We all are aware that the corona virus pandemic has made life difficult and paved the way for an economic slowdown. In a time of crisis like this, the need for emergency funds becomes understandable to everyone. Before we move any further with this article, let me explain the concept of emergency funds first.
What is Emergency Fund?
Emergency funds refer to a specific sum of money that is set aside for financial security during times of crisis. Emergency funds come in handy in case of unforeseen future events like sudden job loss or life-threatening medical illnesses. There can be hundreds of unplanned or unexpected scenarios in which emergency funds may be required. Loss of employment, medical issues etc., are only a few of them.
How much should be the emergency fund? Where should it be invested? These are the first few questions that come to almost everyone`s mind. Let us deal with these questions one by one.
How Much Should Be The Emergency Corpus?
To calculate the amount of needed emergency fund, we first need to calculate the amount of the total monthly expenses. Owing to lifestyle differences, the monthly expenses can be different for everyone. But here is a list of the basic monthly expenses which must be included.
- Household expenses like groceries, medicine etc.
- Personal care expenses
- Child`s monthly educational expenses
- Premium for term insurance, health insurance etc.
- EMI for different loans
(If you want to actually analyze your basic monthly expenses – check the expenses between March 2020 – April 2020. Though your personal expenses will not be covered in this but it’ll give you a rough idea of your overall monthly expenses.)
You can also compare these expenses with the previous month’s expenses. This will help you determine how much you were spending on unnecessary items every month, prior to this period.
Let us say your monthly expenses turn out to be 75,000 per month considering the above-mentioned expenses. In the case of monthly expenses of 75,000 – how much should be your emergency fund?
Case 1 – If you are the only earning member in the family, the emergency corpus should be 12 times your monthly expenses i.e. 75,000*12= 9,00,000. So, an amount of 9 Lakhs should be available at any point in time as the emergency fund.
Case 2 – If you and your spouse, both are earning, the emergency corpus should be 6 times your monthly expenses. Taking the above example, the emergency corpus should be 75,000*6 = Rs. 4,50,000 i.e. Rs. 4.50 Lakhs should be your emergency corpus at any given point in time.
Let me explain the logic behind taking 6 months for the emergency corpus. If both husband and wife are working, the chances of losing the job for both are less at the same time. However, there is no harm in accumulating the emergency corpus for 12 months even if both husband and wife are working.
Now, let us proceed and move to the 2nd point.
Where Should I Invest My Emergency Funds?
The answer to this question on where should I invest my emergency fund is very simple and straightforward – savings account. But this answer becomes complex when people start seeking returns from their emergency funds.
Let it be simple, keep it in your savings account. If you want to earn some returns on emergency funds, open a sweep account for the same. If you want to learn more about the sweeping account and how it works, read the article below.
How auto sweep account works? (Here’s a little hint for you – it works like FD)
There are other options as well like FD and liquid mutual funds. I’d suggest you to keep at least 50% in the savings account with sweep option, 25% in FD and 25% in liquid funds.
So, if you have an emergency fund worth Rs. 9 Lakhs, invest it as follows:
- Savings account with sweep option – Rs. 4.50 Lakhs
- FDs – Rs. 2.50 Lakhs
- Liquid Mutual Funds – Rs. 2.50 Lakhs
There is no need to invest in any other instruments like equity funds, credit risk funds etc.
Always keep this point in mind – an emergency fund is for liquidity at the time of crisis, not for returns.
Access To Emergency Fund
This might seem to be a very unimportant question. But believe me, I’ve seen tens of cases where my clients’ spouses don’t know if they have any emergency fund. Imagine a scenario where the husband is admitted into a hospital in serious condition. And his wife doesn’t know how to arrange the funds. Yes, they have an emergency fund. But the wife has no clue about the monetary value of the fund and how to access it.
So, it’s mandatory that both you and your spouse know about the emergency fund and have easy access to it.
- If it is in the savings account, your spouse should have access to the debit card and pin number.
- FD – Your spouse should know how to break it.
- Liquid mutual funds – Your spouse should know how to withdraw these liquid mutual funds.
Should I Invest Emergency Fund In Equity Markets Now – When The Markets Are Down?
No, you should not do it at any cost. In fact, you should never do it. Here is the main reason why not doing it is preferable.
We are under lockdown at this point in time assuming that our salary will come in the future. The job scenario will be the same after this lockdown is over. But are you sure about this? Do you really think that the economic recovery will be so easy and things will be back to normal? Trust me, I do not know, neither do you.
What if you lose your job and the markets go further down by 30%-40%? There wouldn’t be any other option left except to withdraw money at a loss. This is just some food for thought. You can make a compromise on 2%-3% extra returns but you cannot compromise on basic household expenses. You cannot afford to skip your child`s school fee even for a month.
Therefore, stop thinking about investing your emergency fund in equity instruments.
Are There Any Types Of Emergency Funds Like Long term and Short term?
I have read plenty of articles on how to divide your emergency funds for the long term and short term. And, I am really clueless about how people define an emergency fund as long term or short term. If it can be termed like other goals as long term or short term, why’s it called an emergency fund. It is so because you never know when the emergency may strike.
So, stop investing your emergency fund as long term and short term. The reason being is that an emergency cannot be defined as long term or short term.
How To Build Your Emergency Fund?
Even before getting started with your investments, you should accumulate your emergency fund.
When it comes to building an emergency fund, it can’t be done overnight as it’s a gradual process. Nonetheless, you can start by saving a particular amount of money every month until the needed corpus gets accumulated.
To give an instance, you can set aside 50,000 each month to build an emergency fund of 5 lakhs. Once you successfully create the required emergency fund, you’re all set for hard times. Make sure that you keep it in the savings account with sweeping facility, FD and liquid funds as explained above.
Additionally, it’s preferable to keep the money in a joint account with one’s spouse rather than an individual account. In case you aren’t around, your spouse would still have access to the funds provided they have the required cards.
That’s it for today. Tomorrow, we will discuss in detail the importance of term insurance in the process of DIY planning.
Stay Tuned and keep investing!