A life crisis can hit us when it is least expected. So it is incumbent on us to save for the rainy days while the sun still shines. With memories of a devastating Covid-19 outbreak in 2020 still fresh, many people are now grappling with a new variant called BF.7. The new variant highlights the fact that we are still not out of the woods, perhaps forewarning us of a more severe economic turmoil.
Among all these developments, people battling to survive the financial hardships only go on to underscore the importance of creating an emergency fund for rainy days.
Why An Emergency Fund?
You should have enough cash to take care of your needs during an emergency. Says Kartik Parekh, a Sebi-registered investment advisor: “It does not mean you should start saving because a new Covid variant has surfaced. People should have a crisis fund even if there is no impending emergency.”
Parekh explains that suppose your car breaks down while holidaying with your family; this can be an emergency too. You need money quickly to call a mechanic or hire a tow truck. So, an emergency fund always helps. People could spread the emergency fund across multiple asset classes to cover all emergencies.
Says Abhishek Kumar, a Sebi-registered investment advisor and founder of SahajMoney, a New Delhi-based financial planning firm, "Many would have heard or experienced horror stories during the Covid pandemic when people were asked to make a cash deposit in private hospitals to admit their loved ones. In such cases, emergency funds come handy."
Planning For Emergency Fund
The emergency fund size could vary from person to person based on their income. But such a fund is indispensable for all.
Says Dev Ashish, a Sebi-registered investment advisor and founder of Stable Investor, a financial planning company, “The basic thumb rule is to keep at least 6 months’ worth of essential living expenses set aside as an emergency fund.”
Ashish suggested that if one's annual expenses are Rs 10 lakh, but the core basic expenses are of Rs 8 lakh, then they should set aside at least Rs 4 lakh (50 per cent of basic annual expenses) in the emergency fund.
While the thumb rule of the 6-month core basic expenses as a emergency fund formula is a generalisation, different people in different circumstances will need emergency funds of different sizes.
"A sole earning member of the family of 5-6 dependents and who is working in a high job risk sector will need a bigger emergency fund of say 12-15 months than say for a working couple with only one child,” Ashish further added.
Kumar further adds that an emergency fund could also act as a firewall to one's long-term investment portfolio.
For example, suppose one has invested in a mix of debt and equity instruments without keeping aside an emergency fund. If the long-term investment portfolio is down and then if he meet with an emergency, then it might happen that to tide over the situation one might have to sell their investments at a loss.
Managing Emergency Fund
If the person considers himself impulsive when it comes to spending, he can open a secondary bank account to create his emergency fund. Parekh advises people to keep at least Rs 20 out of every Rs 100 for emergencies in a bank account. The remaining Rs 80 can be in ultra-short-term, liquid, and overnight mutual funds.
It is worth noting that emergency funds are not about return maximisation. They are about safety and having sufficient liquidity. Hence one does not need to put money in volatile instruments.
"Also please don’t think that your credit card can act as an emergency fund. A credit card no doubt provides quick access to liquidity, but after a month, the bill will become due and you will need money to clear the credit card bills,” Ashish further added.
