How well you handle the emergencies in your life are often dependent on how well prepared you are financially.
What’s an emergency fund?
Emergency Funds are designed to help you deal with the unexpected. An emergency fund is typically around 3-6 months of living expenses. This also translates to roughly four months worth of salary.
Why maintain an emergency fund?
Loss of income due to sudden unemployment, health-related issues that your medical insurance wouldn’t cover, etc. could easily cause financial stress.
An emergency fund can come in handy during these times.
What should an emergency fund be?
Liquid – An emergency fund should be accessible in a day or two at most as you might need the money urgently.
Fixed – The amount you put in an emergency fund should be sufficient to meet 3-6 months of expenses.
Not subject to volatility – The requirement for emergency funds can come at any time and volatility is not something you want in this case.
Why expenses for 3-6 months?
Being a contingency fund, it should ideally support you for the duration of any unexpected and financially taxing event.
As a thumb rule, an emergency that lasts for 6 months of no-income can help you overcome financial stress. Beyond this time you should be able to find an alternative solution.
An emergency fund is like a parachute to get you safely out of a “financial crash”.
How to create an emergency fund from scratch?
1. Calculate your average monthly expenses and multiply that figure by 6. This is your target figure.
2. Based on your earnings, decide how much you can afford to set aside towards your emergency fund.
3. Park your emergency fund instalments in a separate savings account, a bank fixed deposit or better yet Liquid funds or short-duration debt funds with a good track record.
4. Keep topping up your fund till you reach your target corpus that can cover 3-6 months of your expenses.
5. Don’t touch this fund till an emergency demands it.
Should you invest an emergency fund in equity or equity MFs?
Equity helps you grow your wealth over the long term. However, considering equity is subject to market volatility, it is not a good idea to put your emergency fund reserves into equity-related investment options.
What’s a better investment option?
A debt mutual fund though is a better option thanks to easy liquidity and much less volatility of such instruments. Take into account the capital gains tax considerations if you choose to follow the debt mutual fund route.
Considering the fact that you can withdraw quickly from debt funds, these can provide a good option to park your emergency fund. These also generally give better returns than savings banks accounts interest (6-8% from liquid funds compared to 3-4% savings bank account).
Emergency Fund Hack #1. Use your credit card as an emergency fund
Your credit card can actually prove to be a good short term emergency fund option as it allows you immediate access to cash while giving you a month or more to pay your dues. It, therefore, makes sense to pay your credit card dues on time and keep the limit free.
Emergency Fund Hack #2. Get your health insured
Having health insurance gives your emergency funds a virtual boost. In case your emergency is a health-related one, health insurance can take care of large medical expenses and can save you substantial sums of money.
Tip: Choose health insurance that provides no co-pay and cashless hospitalization facility.
Takeaways for you:
- Go with 3-6 months expenses as your emergency fund corpus.
- Subject your emergency fund to minimum risk; Liquid Funds are a good option to park your emergency funds
- Keep your credit card limit freed up
- Get health insurance