Settling an emergency fund along with buying the required insurances is very important for money management. This is the most important step in financial planning and the most ignored one also. Incomes are already too stretched to save, so many goals to provide for, so many debts to pay off, having no control on our expenses or lifestyle, we often ignore this concept. When our life is going smooth we stop expecting the unexpected. Once you start living in the real world, you will understand how important keeping emergency fund is.
It is easily accessible cash which you only use in the case of any emergency. Now “emergency” does not require any elaboration. But it should not be something like: Buying your child a PlayStation or your wife an expensive dress etc. on their birthdays. This should be for those unfortunate and unforeseen events which if not managed properly would leave a very bad impact on your financial and personal life.
As I have written above, you may not need any answer to this if you start living in the real world. Let me share with you some practical examples to help you understand this better.
1. One fine evening while you were driving back home, you met with an accident which landed you in the hospital. The doctor wants you to be hospitalized and your treatment might take 2 more days.
Yes, I know that you have medical insurance, but it has to be approved by a pre-authorisation team of the insurer. Insurance desks with hospitals (which takes care of Claims) had called for the day. Hospital wants you to make an immediate deposit, so then you have to bear the expenses.
To add more shock to it, just imagine if the hospital in which you landed was not in the network list or your claims doesn’t get approved for cashless settlement.
2. Where you landed up in the hospital, where your car is also demanding some repairs. Though your car is also insured the Car garage doesn’t have any cashless tie up with your insurance company.
3. The accident was due to your fault and that too with another vehicle. So you may need to compensate the other party also.
4. The injury was so deep that it requires you to be at rest for next 2 months. In this case, your monthly inflow totally depends on the casual, medical or paid leaves you have left with.
5. As you have already spent so much on your medicals and your car repairs, how would you manage your child’s school fee, which is getting due next week?
There can be any degree of emergency. But if you are already prepared to face that situation with the adequate emergency fund you are better placed than others.
I would say that emergency fund is not only important, it’s critical to your financial well-being.
1. For your investments: In the case of an emergency, the first thing that you would do is to liquidate some of your investments which you have allocated for some of your important goals. But if there’s an Emergency fund available you can manage the situation much better.
2. For your Debts: This will help you to avoid unnecessary debts. As to manage that emergency you may like to swipe your credit card or look for some soft loans at the high-interest rate. On the other side, an emergency fund will also help to not let your important EMI payments to get bounced.
How much of emergency fund is enough?
There’s no right answer to this. I believe that it depends on case to case. It should be that figure which makes you more comfortable. You do what works for you. Last year I have recommended many Telecom professionals to keep at least 1 year of monthly expenses for an emergency.
In 2008 I personally kept 8-10 months of expenses as an emergency fund. So there’s no hard and fast rule. It all depends on your lifestyle, income and expenses needs. As a thumb rule, in the normal scenario, it should be equal to at least 3-6 months of your monthly expenses.
How to start saving for an emergency fund?
If at all you want to start your investments simultaneously, then you may start a recurring deposit in bank or SIP in the liquid fund to accumulate an emergency fund.
The best place to keep your emergency fund is your saving bank a/c to make it more accessible in case of emergency.
With the deregulation of interest rates, many bank offering interest on saving account balances in the range of 6%-7% and with the budget proposal of not taxing interest amount of up to Rs 10000/- in any saving accounts, this product looks more suitable to keep the emergency fund.(read – Budget 2012) You have to be disciplined enough to not use this fund for any other purpose but an emergency. You may also select various liquid funds or ultra-short term mutual funds for this purpose.
Nowadays some Mutual fund houses are also offering debit cards with their investments to provide you with easy accessibility to your funds. If your bank is not yielding comparable interest rates, then the liquid fund is much better options. Not earning interest on your emergency money is almost as bad as burying it in your backyard.
The reason most salaried people don’t have any emergency money in the bank is that they have what they think is an emergency every month…and business persons avoid this as they are already so much leverage that they feel that flow of money is always with them.
Came across your blog today. Nice to read the posts by you. I have written an on a similar lines. please give your critical feedback. looking forward to reading more of your posts.