Emergency Fund: Ultimate guide to build and maintain it

8 months ago, one of my cousin was admitted to the hospital. Doctor told to conduct urgent operation within 2 hours.

I and my father were doing some paperwork for insurance. We had cashless insurance. So we didn’t have a burden to pay huge cash instantly.

But to our shock, the person managing insurance in the hospital said something different.

He said that it will take at least 3 hours to process insurance but the operation should be done immediately. So, you need to pay cash now fully. Later you’ll be reimbursed. Else operation won’t be done.

I tried to convince him, but it was a failure. I didn’t say much, as I knew that their hands were also tied.

We had no option except to pay the money. We just paid the money so that operation can be conducted immediately.

After this instance, my belief was cleared that,

Emergency fund can’t be substituted with even cashless health insurance.

Although such cases are rare. But it can happen.

Emergency Fund Planning

Many people are didn’t even aware of emergency fund planning. Only financially sound people plan for this.

Emergency fund planning is important to deal with your rainy days.

In this modern-day, job loss percentage is increasing drastically. If not job loss, youngsters are are changing job frequently. If there is a delay in getting a job. That time would be tough to pass.

Why an emergency fund?

  • In case of job loss or change
  • Medical emergency.
  • Unexpected car expenses
  • Other major and unpredictable expenses

How much emergency fund is enough?

As per the general rule of personal finance,

For the person doing business at least 1-year expenditure and for people in job minimum of 6 months of expenditure.

An emergency fund can be determined based on the stability of your income.

There are two school of thoughts,

some say you should have 6 months of your expenses as emergency fund and some say 6 months of your income.

Actually, it doesn’t make that difference in this. Both are correct in their own way. I agree with both the school of thoughts. You can choose whichever you like. 

If you are starting a startup, then you should have at least 3 years of emergency fund.

How to build an emergency fund equals to 6 months or 1 year of your expenses.

If you have prepared net worth statement and specifically liquid assets part. You can understand how much emergency fund you have now. Don’t consider your salary in your bank A/c and investments for other financial goals.

Find how much you save monthly, If you are following 50/30/20 Rule, then emergency fund should be from 20%. It will take a quite long time to build an emergency fund if you don’t plan your finances properly.

For example:

Your monthly income: Rs. 50,000

Emergency fund required: Rs. 3,00,000 (50,000 * 6 months)

If you are allocating 20% as per the budgeting rule to emergency fund i.e. 10000, it will take around 2.5 years to reach Rs. 3,00,000.

Till that you won’t be able to invest for other goals.

Here, there are two options:

  • Either prioritize all your goals. If you do so, it may be possible that you can invest only 10% monthly for an emergency fund. Then it will take even more time to build this fund.
  • You can use your current liquid investments and save for remaining amount.

It is very subjective. There can’t be same answer for everyone.

Where to invest your emergency fund?

Among various financial product, you should choose a product that protects your principal and fight against inflation.

Make sure that when you redeem your investment, there is no exit load. Otherwise, 2 to 3% will go in that.

Before understanding investment options, understand the purpose.

You are building an emergency fund for your rainy days. So, it should be available quickly. Else, it is of no use. Investment option should be such that money can be withdrawn easily and instantly. Most imp without any charges.

You should divide your fund into 2 categories:

  1. 3 months of expenses in saving A/c. You can use sweep in facility provided by the bank, so you will get a higher interest rate compared to normal saving A/c. Sweep in facility is a balance in excess of stipulated amount, which will be converted into Fixed deposit. In case of emergency, if you withdraw the money, FD will get converted into Saving A/c. Hence no penalty for premature withdrawal.
  2. 3 months/9 months of expenses should be kept in a liquid fund. It is having a higher interest rate compared to saving A/c and fixed deposit. Liquid funds are one of the safe options to invest. There are no exit load charges unlike other fund categories

An emergency fund should be dealt strategically:

  • It should be liquid enough, so that we can withdraw in case of emergency
  • It should get a return at least equals to inflation.
  • No exit load charges

You can solve all this issue by investing it in saving A/c with a sweep in facility and in liquid funds. Liquid funds will provide return and saving A/c will give you liquidity.

In case of emergency, you will have at least 3months of your expense in hand. And other 3 months income can be withdrawn in just 2-day period.

When not to use emergency fund?

This is something I really want to tell you. Human desire is endless. When you find 6-month of your income in your account, fake desires will be created by your mind. Make sure that you don’t use this fund for unnecessary expenses.

The following care should be taken:

  • Don’t use this fund for unnecessary expenses
  • Use it only when your Income is disturbed
  • Don’t use it to fulfil your wants
  • Use it when a major unpredictable expense has incurred and that can’t be managed with your regular monthly income.

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Jigar Chavda

Passionate young guy for personal finance, wealth creation and marketing. He is following his dream and passion to be writer, speaker, blogger and advisor.

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