Better safe than sorry Image: Thinkstock
Life doesn't always play out in a straight line. More often than not, situations crop up without a disclaimer that leave you in a quicksand. It may be a sudden layoff from work, a medical emergency in your family, some loss in business, tax liabilities you never heard of or the worst of them all — an economic meltdown stripping you off of all your savings. Life tends to throw up these nasty surprises at the most unexpected of times. But if you are wise enough with your money, you can always have a life-jacket ready for these unplanned and unwanted situations. Yes, life calls for an emergency fund to get you through these hard times.
This fund is of utmost importance for all age groups. You need to start building your emergency stash right from the day you join a workplace and officially start living without your dad’s money or bank loans.
But it's easier said than done. Right? But fear not, T2 Online is here. We consulted Rahul Agarwal, director, Wealth Discovery, to help you save for these rainy days. Wealth Discovery is a solution provider for trading, investing, financial planning, income tax advice and commission-free mutual fund.
So, what is an 'emergency fund'?
This particular fund isn’t meant for planned purchases such as a house, a new car, a professional course, etc. The fund isn't a set amount either and differs according to age and lifestyle needs. It doesn’t have to be a large, exorbitant amount. Rather, one should start small.
How much should you save?
The thumb rule says an individual must save an amount, which is at least equal to sustain three to six months of unavoidable household expenses of the said individual. The amount varies from person to person based on a number of factors, like the number of earning members in a family, the number of dependents, nature of employment, nature of fixed expenses, EMIs to pay, insurance premiums to pay, rents to pay and other daily expenses.
Now, do you have a health insurance? If you have a corporate one provided by your office or a cashless one of your own, you can rest a little easy. You are much better-equipped to handle a medical emergency situation compared to someone with no health insurance. But you should still exercise caution.
You should start planning and building an emergency fund as soon as possible after starting your professional life. The needs are comparatively smaller early on, making it easier to build up your reserve.
How to structure your fund and where to invest?
Emergency funds, by definition, should be easily accessible at all times. It’s hard to predict the scale of an emergency but it can be correlated to one’s situation for e.g. if you are single, living with aged parents, have kids or if you are self-employed. It's important to keep one’s individual situation in mind before allocating or investing in your emergency fund.
No matter how easily accessible an emergency fund may be, nothing can beat the comfort of having some cash in hand. Therefore, at least 10-15 per cent of one’s emergency fund should be in cash.
Next, allocation of the emergency fund should be in a savings account with auto sweep facility wherein, when your savings account balance exceeds a certain limit, the excess money is put into an FD. The threshold can be anywhere between Rs 25,000 and Rs 1 lakh. The FD would have a minimum maturity period as decided by the bank and there can be penalties for early withdrawal. But that should not be a consideration for emergency funds.
A certain portion of the emergency fund can also be deployed in liquid fund. Liquid fund is a category of mutual fund, which invests primarily in money market instruments such as certificate of deposits, treasury bills, commercial papers and term deposits. These funds have varying level of returns. For example, the range of returns for liquid funds with duration of one to six months is 0.9 per cent to 4.5 per cent. Withdrawals from liquid funds are processed within 24 hours on business days and the cut-off time is generally 2pm. It means if you place a redemption request by 2pm on a business day, then the funds will be credited to your bank account on the next business day by 10am.
A portion of the emergency fund can also be kept in highly liquid debt mutual funds. The returns on these funds are secured and at present are in the range of 7.5 per cent to 10 per cent depending on the type of funds. The idea behind this allocation is to have a safe and liquid investment that gives higher returns than a typical bank fixed deposit within a similar time frame.
My organisation provides medical insurance. Do I still need an emergency fund?
If your company provides you with a health insurance, you still need to have an emergency fund because you need have sufficient cushion for untoward, unplanned situations which are not just limited to medical exigencies.
Although it can be argued that medical emergencies are the most common sort of emergencies, it's not the only type. And even in medical-related cases, an employer-provided insurance cover might not be enough. Health insurance does come with reasonable restrictions and caps. Even with cashless insurance, sometimes you have to deposit some cash upfront at the hospital. Therefore it is always a good idea to have an emergency fund for situations like these.
Shall I take a loan to build my emergency fund?
No, you don't need to be in such a rush. The whole idea to have an emergency fund is that one should not have to take a loan in cases of emergencies. Hence, taking a loan out to build an emergency fund sort of defeats the purpose. If you think you cannot save enough or do not have enough in the emergency fund, do not panic. Just keep saving every bit you can and over time, you will have a sufficient kitty. It is, however, important to have access to emergency funds for example access to soft loans from friends and family on easier payment terms. A credit card with some spending limit can also serve as the last resort in case of an emergency.