by Namrata Singh, CFP & Chaitali Shah, MA (Economics)

“Things that have never happened happen all the time. The correct lesson to learn from surprises is that the world is surprising. We have to plan for our plan not going according to plan”

By Morgan Housel

What is an Emergency Fund?

An emergency fund is an amount set aside to tackle unforeseen circumstances or emergencies. It helps one create a financial cushion and stay afloat without relying on credit cards or high interest loans.

Why do we need an Emergency Fund?

Job loss, a life threatening illness, a major repair of one’s house or car, natural disasters, etc are some of the contingencies that can impact one’s life with no warning. The current pandemic and lockdown is an unprecedented contingency, which has caught people off guard and ruined lives due to lack of financial planning and awareness.

Benefits of having an Emergency Fund

An Emergency Fund works like a safety net and reduces stress levels. It is the first step towards financial freedom.

It ensures that one does not derail his/her long term investment plan for contingencies that may arise from time to time.

It also ensures that one does not have to take untimely loans and thus avoid getting into a Debt Trap.

How much should be set aside?

One should set aside at least 6 months of living expenses (which includes debt/loan EMIs) towards emergency funds. This allocation should increase with age and inflation.

For example: If the monthly expenditure is Rs. 50,000

One should work towards building an emergency corpus amounting Rs. 300,000 (Rupees Three Lakhs Only)

An estimation of your monthly expenses is a prerequisite to ascertain the amount to be kept aside as emergency fund.

Where should one invest the Emergency Fund?

Emergency Fund can be parked into combination of the following:

Savings Account

Bank Fixed Deposits

Liquid Funds

The aforesaid low risk options help us to withdraw funds immediately or at one day’s notice.

One should keep about 30% in the bank account to meet immediate contingencies. The remaining 70% can be invested into bank deposits or liquid funds.

(A liquid fund is a category of mutual fund schemes that invest in debt and money market securities with maturity of up to 91 days only.)

It is important to increase the emergency fund in line with the increase in expenditure. One must build discipline to ensure that the emergency fund is used for contingencies only and not for any other purpose.

Greek philosopher Heraclitus said, “Change is the only constant in life” and with change there is uncertainty. Most of us have learnt that the hard way, with the recent pandemic. Emergency Fund is now a necessity and helps us prepare well for the future.

__________________________________________________________________________

Namrata Singh is a Certified Financial Planner with more than 14 years of experience in banking and wealth management. (namrata@asinvestment.in)

Chaitali Shah, MCom & MA (Economics) was a Financial Economics – Faculty at Wilson College, Mumbai (chaitali_s@hotmail.com)

(Please note all views are personal)

#ChaitaliShah #NamrataSingh