In 9 out of 10 unexpected events, you would fare through if you have Emergency fund.
Emergency Fund
Pink slips everywhere, more than 46,000 workers in US-based tech companies have been laid off in mass job cuts so far in 2023 and it is expected Indian technology services firms would follow with 80,000 to 120,000 lakh layoffs over the next two quarters citing overhiring during Covid, a news report said, quoting HR sources.
What happens if so many people lose their jobs unexpectedly? it is an emergency situation in their lives.
Being a banker working in debt management I frequently encounter such people defaulting on their loans and facing a challenging situation. For many of them, life was smooth and they never expected such an emergency situation with no plans to face it temporarily.
According to a survey done in America
- 51% of people have less than 3 months of saving for meeting their critical expenses.57%of millennials, 44% of Genexers and 49% of baby boomers have less than 3 months of savings.
- If hit with an unplanned $1,000 expense, 44% of people would pay it with their savings, compared with 20 %who would pay with a credit card, 15% who would pay it but have to cut other spending, 10% who would borrow from family or friends, and 4% who would take a personal loan.
Why do you need an emergency fund?
As per the dictionary Emergency means “ A serious, unexpected, and often dangerous situation requiring immediate action”
- A job or business loss(Unemployment)
- An accident or disease(Urgent medical treatment)
- Emergency home repair
- Emergency Car Repair
- Unexpected death of a family member
Above all fall under emergency which are serious, unexpected events that require immediate action.
And we need cash for this immediate action in these unforeseen events and thus it necessitates the creation of an Emergency fund for all.
“Save when you don’t need it, and it’ll be there for you when you do.”― Frank Sonnenberg, The Path to a Meaningful Life
Now after realising the emergency fund and its importance, it is critical to know…..
What expenses are to be covered under Emergency fund? How many months of expenses it should have? How to create Emergency fund under present conditions? Where to keep this saved Emergency fund?
Let’s review in detail all the factors while building our emergency fund.
What expenses are to be covered?
We should have clarity on what has to be prioritized. A clear understanding of “Needs” and “Wants” will definitely help in this.
Every Indian citizen knows the importance of “Roti, Kapdaa aur Makaan”…..
Yes , below expenses are critical to be covered.
Housing -Roof over the head,
Grocery- food for energy,
Regular Medical expenses
Children School fee
Mobile bill payments
Minimum Emi payments for running loans.
While understanding the above critical expenses , we also need to know what is not to be included.
There is no chance of including expenses for entertainment, we can’t go for eating outside or order a pizza on swiggy when there is no job.
The same is with Netflix subscriptions.
We also can’t save money as a part of the Emergency fund for those upcoming Amazon/Flipkart big days etc.
So we have to be sensible and understand the fact the more expenses your emergency fund needs to cover, the more money you need to save.
Tracking your average expenses will help in identifying the essential items which can be included in saving for an emergency fund and which expenses you would cut in the event of an unexpected situation.
Tracking expenses is altogether a different subject which I will explain separately in another letter.
How many months that emergency fund should cover your essential expenses?
The general thumb rule is emergency fund should cover min of 6 months of your expenses.
But this number of months depends on 3 factors
- How secure your income is.
- Number of income sources in your famil
3. Number of dependents in your family
4. Your employability or skills/talents you have.
5.Personal Preference.
In general below table advises the recommended number of Months needed
If you are working in an organization where the attrition rates are low like a job in govt department may not require a large emergency fund.
Similarly, the situation with rare skills/experience/talent or a highly demanding niche field helps to get a job immediately and may require a planning for lesser number of months.
On the other side if you have little job security you might prefer a larger emergency fund.
In one of his article, Mr.Benleforte says that “Personal finance is the art of balancing the numbers with personal preference. If having a large emergency fund lets you sleep better at night, then go for higher months’ coverage.”
How much is to be saved? How to make an Emergency fund with available resources?
Tracking your expenses for a couple of months will help you to know
- What is your average spend on essential items?
- How many months worth of Emergency fund that should cover you expenses?
- By what time you want to create this fund?
- How much savings you have.?
Now let’s take an ideal situation where you require Rs 40,000 per month to cover your essential expenses and you want to create 6 months emergency fund in next 6 months, and you have a saving of Rs 60,000.
- Your goal would be to have Rs 2,40,000 (i.e 6 months*40000) saved in your emergency fund.
- As you already have Rs 60,000 in your savings account you need an additional corpus of Rs 1,80,000.
- If you want to build this emergency fund in next 6 months you require to save Rs 30,000 per month.
In excel it might look easy to calculate and arrive at certain figures, but in practice, it is very difficult to save that much amount with available limited resources in daily life.
I am listing some tips to make an emergency fund
- Pause all your investments- Emergency fund is the first priority of personal finance, you cant prefer Monthly SIP or buying shares over it. So stop all your investments till an emergency fund is not created.
- Pause your entertainment or lavish expenses- You can’t be tempted to buy a 72 inches TV or the latest model of iPhone 14 on amazon’s big billion days. That vacation to Kashmir or dubai can be postponed.
- Add lumpsum amount : Bonus you get, dividends you earn, gift by parents or in-laws should be added to reach target corpus early.
- Create a separate account so that you don’t touch this amount in all the contexts.
Where should the emergency fund be saved or invested?
Now with all knowledge and persistence you have created an emergency fund but can we invest this fund to grow?
There are 2 schools of thoughts,
One says that an Emergency Fund can’t be invested anywhere and risk the money under any circumstances.
Because people rely on Emergency fund when they lose their job and it happens most during recessions like the one we are facing now in tech industry and covid like situations.
What happens to the stock market during a recession? It goes down.
Imagine you require this fund when you lose the job but your invested amount becomes 50%, what is the point of planning the emergency fund and its coverage?
Another school of thought says that this sort of contingency fund can be parked somewhere which has 3 criteria
- Capital should be 100% safe
- Immediate redemption i.e easy accessibility to funds.
- Returns >= Inflation.
So it is suggested that an emergency fund can be invested or parked as below
- 10% interms of cash
- 20% in bank account
- 30% in Liquid mutual funds which are as good as FD , can be liquidated in 24 hours and slightly better returns and most importantly safe.
Review your fund :
You have successfully planned and created Emergency fund with all persistence, but that is not enough to create once and lived peacefully.
On account of lifestyle inflation, it is important to review the fund every 2 years and top it up if expenses have been increased.
Moreover, God forbids it has been utilized, the priority is to restore it immediately.
Final note :
In my interactions with colleagues, friends and also my bank customers I have realized that hardly anyone has given importance to this emergency fund irrespective of their financial status. This leads me to write this post in detail, for many it might look very basic but it has got its own importance.
Many of them say that as they have credit cards with higher limits and also many financial institutions are giving personal loans with a click of a button,so it is not required to create an alternative Emergency fund.
Partly I also agree that having a credit card and eligibility for a preapproved personal loan gives a lot of cushion in an emergency, but it has to be used only when you have got the capacity to repay back before it revolves, otherwise, you might end up paying 35–40% as an interest, and it would be very difficult to come out of that loop.
Moreover, everyone does not have credit cards and easy access to personal loans. For those who are in their early careers and have average salaries it would be difficult for them to get easy credit, on the other side it would also be difficult for them to create Emergency fund but it calls for immediate action for them in this aspect.
Please keep watching this space, I would be coming up with topics of personal finance and productivity.
RECAP :
- Emergency fund creation should be given priority over all other financial goals.
- Track your expenses for couple of months and arrive at average amount required for covering the essential expenes.
- Based on your income security and personal preference decide how many months your emergency fund should cover your essential expenses, thumb rule says 6 months
- Your emergency fund should be 100% safe and easily redeemed.
