In your 40s, you don’t just need an emergency fund. You need a ‘confidence fund’

But when one turns 40, the devil is often found wandering in the details. If 40 signifies a higher income and social strata in India, it also means unavoidable expenses that are your responsibilities. And these are heavy responsibilities indeed.

Spending Rs 3-4 lakh per year, per child is not unheard of when it comes to this demographic of 40-somethings earning salaries equivalent to their age. Since most of them work in one metropolitan city or another, simple expenses such as school fees and bus charges can reach eye-watering 6-figure amounts.

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Then there are extracurricular activities that these children participate in, which is a given. Not to mention coaching for the life-changing entrance exams that often cost as much or close to the school fees.

Most of these costs are something you cannot defer. You may also have a running home loan, another expense you can’t delay. Since few parents tend to note these costs, they often get lost before making an expense list. Their recurrence is also varied as schools usually charge quarterly or annual fees.

Just an emergency fund may not be enough

The case for an emergency fund is thus a no-brainer. The Meta and Twitter layoffs are a wake-up call for even those who believe they are the best India has to offer. But deciding the emergency fund amount is a more complex exercise. After all, how much is truly enough?

This is why we suggest that people simply use their take-home salary as a base to decide their emergency fund amounts. Four months of take-home pay is more straightforward to arrive at as a final number than six months of expense.

However, an emergency fund with four months' salary is “just” an emergency fund. What we would like to recommend for the 40-something high earner is a step further. Go beyond and build a confidence fund. A fund that holds enough to help you through a challenging period and do so confidently.

How big should be your confidence fund?

Quite simply, go beyond the 4-month rule. Instead, build a fund that can cover annual one-time expenses and debt obligations. The idea here is not merely to be prepared for any emergency but to outlast one and do so with confidence and peace of mind.

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Say, there is a family with an annual, post-tax income of Rs 30 lakh. The family has a loan that comes with an equated monthly instalment (EMI) of Rs 1 lakh hanging over their heads, and two children with yearly education expenses of Rs 4 lakhs. This family should have a confidence fund of Rs 27.5 lakh. In case the family has only one child then the confidence fund will be Rs 23.5 lakh. Moving some of your investments meant for negotiable long-term goals or adding your latest bonus to this fund should be considered.

Your confidence fund must account for expenses such as your child’s annual school expenses, your home loan EMI or rent, and living expenses for a year (excluding things like what you’d spend on expensive leisure activities such as a vacation in Venice)

It’s why prudent professionals in their 40s (when the vast majority see such high incomes) often have a much higher emergency fund than what the thumb rules dictate.

But most individuals rely on their cash in a bank or existing investments since these are often significant amounts by themselves.

How to build your confidence fund?

While this can work in a pinch, it’s better to allocate the “confidence fund” in high stability, low-risk debt funds. Ideally, you should already have this kind of money as part of your investments and should simply relocate them to the right investment avenues with adequate liquidity.

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However, in case you have gaps in your overall wealth, starting a SIP in liquid funds or ultra short-term debt funds or even FDs to achieve this goal within a year or two should be your priority. How long you will take depends on your overall savings capacity and cash flow. If you earn Rs 30 lakh per annum post-tax, creating a confidence fund of Rs 27.5 lakh from scratch will need a SIP of Rs 1.1 lakhs running for 2 years. A somewhat smaller fund of Rs 20 lakh will take a similar amount per month and 1.5 years.

For most people in their 40s, the solution will involve a mixture of SIPs and re-allocating existing investments – even if this means withdrawing from direct equity or equity MFs to the tune of the required confidence fund corpus.

Having a separate fund gives you the necessary peace of mind and assurance that even a global downturn won’t come in the way of your life and all that’s critical to it.