JOIN USUncertainties at times haunt us like you never imagined. Be it a failing washing machine, medical emergency, accident, loss of job . Or, view the bigger scene like the recent Chennai floods, which threw many people simply out of gear. Loss of household goods, floating cars, disease...
Are you ready to handle the contingencies?
The financial consequences could be minimised, if not totally mitigated, if only an Emergency Fund is in place. In a country like India, where majority of the people are depending on monthly wages, a blown diffusion would drive them into near-bankruptcy.
What is an Emergency Fund (EF)?
Emergency Fund, an essential component of good financial planning, is designed to provide financial back-up to cover unexpected expenses. Prior to the 2008-financial crisis, wealth management experts recommended that your EF covers three months worth of expenses.
Now, the new financial wisdom is to have at least six months equivalent. Remember, in an emergency, we don’t entertain holidays, fancy new clothes, dining out or other luxuries. Make small goals initially, setting aside a certain sum every month, before working your way up. Review the fund periodically due to ongoing inflationary pressures.
Where to keep the fund:
The fund should be reliable, easily available. EF investment must carry zero or very low risk. In other words, savings account / bank FDs (Fixed Deposits) are good, while stocks are bad. The FDs can be linked to savings accounts, so that the auto-sweep-in facility from the FD can facilitate the transaction without breaking the FD. Thus, FD interest can also be earned. Keep it away from normal checking account to build a psychological divider between your spending routine and your EF.
Classify EF into two categories:
Short-term Emergency Fund can be in an accessible account, which probably fetches small interest. A debit card and cheque book privileges are desired.
The purpose is to address smaller emergencies, such as car/two-wheeler repairs, fixing/replacing a broken household appliance etc. Long-term Emergency Fund allows you to save for large-scale emergencies such as job loss, natural disaster, and earn a slightly higher rate of interest.
Make savings part of your regular budget:
Set up a standing instruction for monthly auto-transfer from your regular savings account to EF savings account. Once a lump sum amount is accumulated in the EF-Savings account, convert into an EF-Fixed Deposit. Ensure FDs at maturity are constantly renewed.
Make it slow, but sure:
Any action you take to establish an EF will do you good. Don’t feel shy to start with a small amount of savings each month, but try to increase it whenever possible. For instance, when you get a tax refund, add it to your fund. Save, rather than blow your excess money. Avoid Mutual Fund-SIP route, as EF precedes other forms of investment which have their own nitty-gritty. Write your daily expenses. When you see the money dwindling, your natural instinct is to spend less. We have seen that many households waste about 10% of its income each month. Look for the money leaks in your budget. Once your EFs commitments are fulfilled, you can venture out into other forms of investment options like mutual funds and equities, among others. An EF can mean the difference between financial failure and financial success. Not only must you develop discipline to accumulate one, but an EF prepares you to reduce your dependence on borrowed money, often at high interest rates.
(The writer is a former banker)