Life is full of uncertainties. Emergencies often come unannounced, and they are irreversible. Hence, if you are unprepared for them, there is not much you can do. Life can get messy. Every individual must have an appropriate financial support system for such an emergency situation – you need an emergency fund. Today, we will discuss everything related to emergency funds in detail.
What is an emergency fund?
An emergency fund is a corpus of money you set aside to tackle the unexpected financial situations that life throws at you. It will be your safety net and protect you when an uncalled situation comes.
Emergencies do not necessarily mean medical emergencies. Anything and everything that is not included in your daily budget that is critical will come under emergency. It could be a loss of pay, sudden expenditure, major car repairs, etc.
Apart from being a safety net, emergency funds help you live a stress-free life. When you know you are protected to face all life’s uncertainties, you can sleep peacefully at night without worrying about the future.
Important points related to emergency funds
Now that you understand the importance of an emergency fund let us talk about the essential aspects of emergency funds. First, you have to keep your emergency funds in liquid assets. Even though your funds are liquid, you must not use them for other purposes – shopping, vacation, etc. You should touch your emergency fund only in case of an emergency.
Keep your emergency funds in assets where you can make withdrawals easily and quickly. Also, you must ensure there are no exit loads or penalties if you withdraw your emergency funds. Your invested amount should be safe (the value should not go down), and you should get decent returns on your corpus (it should be at par with inflation).
How much to keep in the emergency fund?
You cannot build an emergency fund overnight. It has to be done gradually. Hence, if you have not done it by now, you should not delay it. Set aside a particular amount to create your emergency fund. The crucial question is how much to keep in the emergency fund. So let us answer that.
Depending on your income and expenses, you can have three to six months of your monthly income in an emergency fund. For example, if you earn Rs 1 lakh per month and Rs 60,000 goes towards household expenses, then you can create an emergency fund with a value between Rs 1.8 lakh and Rs 3 lakh.
The numbers can change depending on your financial situation. If you have a volatile job or a business, you should aim for 12 months’ expenses in your emergency fund. Similarly, if you have EMIs, then six months of EMIs is the least you should have in your emergency fund.
If you are unsure of the amount to keep in your emergency funds, it is best to consult a financial advisor. Experts at Right Horizons can help create your emergency fund.
Where to keep your emergency fund?
You need to understand one thing – for most emergencies, you will not need the complete corpus on the first day. Hence, you may not keep everything in your savings account to have 100% liquidity.
You can invest your emergency funds wisely and generate a return from them. However, earning higher returns from your emergency fund should not be your priority. If you are a conservative person, you can keep 10% of your emergency fund in your savings account. You can also keep your money in fixed deposits but ensure there are no penalties for premature withdrawals.
You can keep a part of the total emergency fund in liquid/ultra short term funds for a little higher returns. Look for funds without exit loads while planning for your emergency funds. Keep in mind that equity funds may provide you liquidity, but the market risk make them unsuitable for this requirement as one may not want to withdraw from equity while in a downturn. Generally, you get the amount within one working day of your bank account. So if you put in a request today, you can expect the money in your bank tomorrow.
Consult an advisor
If your monthly expenses are high, your emergency fund needs to be of a decent size. It is good to layer your liquidity as you may not require larger sums of money immediately. The reason is that as liquidity increases, the returns decrease. Hence, better planning of your emergency funds will make some difference to the growth of your corpus. Reach out to Right Horizons for all your financial worries.