Which are the best mutual funds? Which stock will perform the best in the next 5 years? We all need to know all this. We all want to grow our money as quickly as possible, but none of us understand that we are just one emergency away from going bankrupt. As bad as it sounds, as uncomfortable as it sounds, it is true. The latest report on media in Asia states that people working out of companies at 71% cover their hospital costs out of their pocket out of their savings. If anyone’s or anyone’s family member’s hospitalization gets extended, the entire savings of employees at 70% will be lost leaving them bankrupt. And here we are talking only about hospitalization. Anything can happen to anyone. You can lose your job. There can be some repair work in your house. Your car can break down. There can be some legal issues. You can have some personal problems. Anything can happen to anyone, if you have not planned anything for these emergencies, then the majority of Indians can go bankrupt anytime, now I don’t know about you, but I am very scared to live with such uncertainties.
Now here some people will say that if there is a sudden medical emergency, then there is health insurance, you suggested it, but what about the other emergencies that we just mentioned, there is no insurance for them, which is why it is super important to build a safety net also called Emergency Fund keep in mind that building your emergency fund should be the first step of financial planning, yes this article is called financial planning 101, so before you start asking what are the best mutual funds and stocks, which are the best you should be.
What is an Emergency Fund?
Now you know what an emergency fund is and how to build an emergency fund, I have told you why you should have an emergency fund, but how to create this emergency fund how big should it be, and if yes, where should it be kept, you will get the answers to all these questions in this article. So, now we know what is an emergency fund, why should it be, now we know how big the emergency fund should be.
How big the Emergency Fund is?
If we believe the experts, then according to them, you should have an emergency fund equal to your expenses for 6 months. Supposedly your monthly expenses are 25000.
So multiply by six. 150k, you should have this much emergency fund, but somehow I do not subscribe to this theory. Firstly, this answer is quite misleading. Secondly, a lot of these nuances are missing from this answer. Let me explain. According to me, emergency funding is the biggest topic of personal finance. Yes, it comes under the broad umbrella of personal finance because it is personal for everyone. It can be different for everyone. Now, according to me, the amount of emergency funds can be different for everyone. For some people, 6 months are enough.
For some people, it is 12 months and for some, it can be 18 months as well, so how do we decide? Let me see, according to me, the biggest point is the amount that can provide peace to you and your family. Now for me, the six-month emergency fund is not going to work at all. I can’t make peace with that. I might sound a little more conservative, but I need at least a 12-month emergency fund. According to me, there is one more nuance that many experts miss. That is, your bank statement has a monthly expenditure, multiply it by 6, 12, or 18, and whatever amount comes out will be a very unrealistic stick. Let me explain, supposedly my monthly expenditure is 50,000 including everything. Now, you don’t have to do this. That my monthly expenditure is 50000, I should multiply it by 12 and my emergency fund should be 6 lakhs. If you are a regular salaried employee, then I am sure you have a lot of extra expenses like going out on trips, going shopping, eating out in expensive restaurants and you are doing all this and You should also do this. If you are earning money, then you should also know how to spend it,
But in case of emergency, like you are not going to spend extravagant expenses like traveling, going out to expensive restaurants, shopping, etc. then I think you will focus on your basic expenses. So according to me, you should create an emergency fund according to your basic needs every month, otherwise, you will have to create a very big fund and you are going to live under a lot of stress. So if your monthly expenditure is 50000, then out of that, if your basic expenditure is 30 to 35000, you should focus on this. Taking the figure of 50000
An emergency fund should be made and not 50000. Now that we have understood how big the emergency fund should be, we have to know how to make an emergency fund so big.
How do we plan an Emergency fund?
Like how do we plan it? The first point in this is that you will have to plan it from your first or second salary. Step one should be to plan your insurance and step two should be to plan your emergency fund. SIP, mutual funds, stocks, all this has to be done later. Ah, to do this, you will have to invest a fixed amount every month from your salary. So suppose your salary is 50000, I will invest 20% of it.
But that means as soon as you get your salary of Rs. 10000, you should put a standing instruction in it so that it goes from your salary account to your other account. For whatever reason, if your obligation is high that you have to pay EMI, you have some loan, you have to pay it off. After sorting out all this, you can put a standing instruction on the amount that is left. What we have said is that as soon as your salary comes, you should put a standing instruction on it, which means your money should move from your salary account to another account, but this is another account.
Where Do We Invest Our Emergency Fund?
What is it, where do we have to invest the money? Is this another savings account? Do we have to put the money in FD? Do we have to put it in a mutual fund? That means the money is coming. For this, you have to know that three things are very important in an emergency fund.
First, the fund should not be volatile, which means it should be stable so that whenever you need money, it is available to you.
Second, the fund should be immediately available The keyword here is immediate, meaning it should not happen that you need money in an emergency and the money is coming to you after two days, you need it right now, meaning you need it right now.
Thirdly, the fund should at least beat inflation, the logic behind this is that suppose you created a fund of 3 lakhs for yourself and you did not use it for 10 years, when you need it after 10 years, due to inflation the value of that 3 lakhs became only 1.5 lakhs, so this should not happen, now with this concept we have to see which good options are left with us for an emergency fund, now it has become very clear that equity mutual funds and stocks are not in our options because both are very wallet-thin in the short term Their value keeps fluctuating a lot and we need stability in our fund, so we are left with three options, first is a savings account, second is FD and RD and the third one is debt funds Here my first pick would be a combination of savings account plus FD In this I get the stability of a savings account I get the option of immediate liquidity and the returns of FD We can achieve this by enabling auto sweep in our savings account Above a certain threshold hold And I would suggest you to have a separate savings account for the same. and I would park at least 50% of the money in this option.
Debt Funds for Emergency Account:
The next option is debt funds. Now, in debt funds, you have 8-10 options. Ultra-low duration, low duration, liquid funds, liquid funds, etc. Risks and rewards are different in all these categories. But since we are building an emergency fund, we would prefer low-risk and decent returns. For this, we would choose liquid funds in the category of debt funds because they have extremely low wallets and currently they are giving returns of 7%. The settlement of liquid funds is t+1, which means if you place a redemption request today, then.
You will get the money by tomorrow. And in between, you have the option of a credit card. Now, many viewers must be thinking why are we suggesting both liquid funds and FDs? Currently, liquid funds are giving less returns than FDs, but now they are giving less returns and this doesn’t need to happen in the future either. For example, in 2014-2015, liquid funds were giving you a return of 9 to 10 percent while FDs were giving you 8 percent. So we don’t know which one will give you better returns in the future. So it is better to have both to diversify our portfolio.
10 to 20 percent of your Emergency fund should be in cash or the form of a gold coin:
I would like to add here that no other expert will tell you or usually when someone asks me, I advise that 10 to 20 percent of your fund should be in cash or the form of a gold coin, preferably cash. But here people think that cash is not giving you any returns and that keeping gold coins is not safe. Then why am I recommending this? I recommend this because emergencies never come with any notice and it is very difficult to predict the nature of emergencies. Supposedly your banks may be cyberattacked. Stops working
If your ATM stops working, you are unable to withdraw cash from anywhere and you are unable to use your funds, your phone stops working, so in such a situation, only cash or gold coins will help you. Now, I know, there is a 99% chance that it will not happen, but since we are preparing for the emergency fund, we will also consider the 1% option. Ideally, we should have a combination of all the above options. A 50 to 60% and a separate savings account with auto sweep enabled. 30 to 35% in liquid and arbitrage funds and 10% in cash plus gold coins. We have discussed almost every aspect of the emergency fund.
Special Advice for Beginners:
I will give you two more tips related to emergency funds first it is not a one-time process it should be continuously updated and changed with your lifestyle and needs and then it should be reviewed every one to two years I have not seen this trend in 20
I have seen a lot that especially after 25-26, every one or two years your lifestyle and needs keep on changing, so people who are in the late 20s and early 30s please be a little more mindful about it secondly if for any reason your emergency fund has been used up then your plan of action should be to immediately replace it and restore it this one is quite obvious that you should always have an emergency fund so if you have used it then you should also replenish it so this is the article that we made on emergency fund we hope that we have covered all the points for you.
Conclusion:
The article emphasizes the critical importance of having an emergency fund as the foundation of financial planning. It highlights that many individuals risk bankruptcy in emergencies due to inadequate preparation. The emergency fund serves as a safety net to handle unforeseen circumstances like medical emergencies, job loss, or unexpected expenses. The recommended size of an emergency fund varies depending on individual needs but generally ranges from 6 to 18 months of basic expenses.
The article suggests a diversified approach to building and maintaining an emergency fund, including:
- Savings account with auto sweep for stability and liquidity.
- Fixed Deposits (FDs) for higher returns while maintaining access.
- Liquid debt funds for diversification and inflation-beating returns.
- Cash and gold coins (10-20%) for immediate availability during rare scenarios where other options fail.
Regularly updating the fund to align with lifestyle changes and replenishing it immediately after use are also emphasized as key practices.
FAQs
- Why is an emergency fund necessary?
An emergency fund protects against unexpected financial shocks like medical emergencies, job loss, or urgent repairs, preventing potential bankruptcy or financial stress.
- How much should I save for an emergency fund?
The recommended amount varies, but it typically ranges from 6 to 18 months of your basic monthly expenses (not including discretionary spending).
- Where should I keep my emergency fund?
A combination of options is best:
- Savings account with auto-sweep for liquidity.
2. Fixed Deposits (FDs) for stable returns.
3. Liquid debt funds for inflation-beating growth.
4. Cash and gold coins for immediate access.
4. When should I start building an emergency fund?
Start immediately, ideally with your first or second paycheck, by allocating a fixed percentage of your income every month.
- How often should I update my emergency fund?
Review and adjust your emergency fund every 1-2 years to reflect changes in your lifestyle, income, and expenses. Replenish it immediately after any withdrawal.