One of the most important lessons we learnt during this COVID crisis is about how well prepared we are during an emergency. How well stocked are we in terms of food. How well equipped are we in terms of staying indoors without being able to step out for ages. And most importantly, how financially stable are we and how much backup funds do we have stowed away incase of an emergency where you don’t have a job or cant run your business as usual.
Let’s look at what an emergency fund is. Where to save the money you set aside for emergency and how to structure it best so you earn a return from it.
What is an Emergency fund?
As the name suggests, an emergency fund is a pool of money you set aside to help you out during an emergency. It is kind of a rainy day fund. This emergency could be anything from a job loss to an unforeseen medical expense. What is important is that the money is readily available when you need it. Here are some reasons you may find an emergency fund
When do you need an emergency fund
– Lost your job and you have to search for another one
– Sudden medical emergency for you or your family that needs money
– Sudden need to repair your house or car
– Natural disaster or pandemic that de-stabilizes your income
How much money to set aside for emergency?
You should have 6 months worth of expenses in your emergency kitty. Nothing more, nothing less. Anything less than that means you are exposed to have a shorter cover. If you have more than that then you have not deployed your funds optimally, for the additional funds here could have been put to better use elsewhere.
Think about it, if you have lost your job, 6 months is sufficient to find another one. Most medical emergencies should be handled via the insurances and medical policies you have. If you don’t have one, get that first. Medical emergencies and other issues should not take up more than 6 months worth of your expenses. If they do, then that is for you to explore other options for funding.
Where to save money for emergency
This is an important part. The money you set aside for urgent need and a rainy day should be readily available on short notice. At the same time, it should also not be idle and should generate you a decent income. So key to the question of where to park your emergency fund lies in your personal needs and the balance you can find.
This will depend on each person, someone who has an expense of Rs.10,000 may have a different approach than someone who have a monthly expense of Rs.1,00,000. So, let me show what my emergency fund plan is and you can decide how to structure one for yourself.
In my case, my monthly expenses are about Rs.75,000. I have set a goal of having an emergency corpus to cover for 6 months of my expenses which is Rs.4,50,000.
Short term readily available
This is money that will be available to me within a couple of hours in case of an emergency. I have only set aside 0.65 months worth of expenses under this, that is about Rs.50,000.
- My money in this bracket is completely held as cash.
- This is cash held in my bank accounts acting as my minimum balance
- If the minimum balance for an account is Rs.5,000, then I hold Rs.10,000 in it. That way, during any emergency, I can take the complete balance out and have a longer time to fill it back up. This is because most bank accounts consider an average amount held in the account during the quarter or month
- This is earning me about 2.5% to 3.5% interest per annum
Backup plans for immediate need of money
Apart from this half month worth of expense I set aside, for immediate needs I have the following as back up
- Credit cards for purchases. I will have 30 to 40 days to pay this back. So in case of emergency, I can liquidate any of my other investments in the Longer term category during this period
- Friends, Family and Father-in-law: I can always ask for help in times of need and pay them back in 10 to 20 days time frame. Again, this gives me sufficient time to liquidate other investments in the longer term category.
(Here are 9 ways you can get money on very short notice in case of an urgent desperate need for money)
Mid term- Money available in 2 days
This is money that will be available to me in 2 days or less during a crisis or need. I slotted to hold 1.3 months worth of money in this form. That is Rs.1,00,000. My money is kept in Liquid funds. Depending on your preference, you can keep this money in Fixed deposits too.
Liquid funds for parking Emergency Fund
Liquid funds offer about 6% to 8% returns on your investment. They are easy to invest in and you can sell your funds and have the money in your bank in 2 days (working days mind you!). I use ET Money to hold on to these funds, so far they are reliable and I have redeemed my liquid funds a couple of times to test it and in need. The money reaches my account in 2 days or less.
Apart from the advantage of earning higher returns than holding in a bank account or fixed deposit, liquid funds are better than mutual funds. Unlike mutual funds, they do not have an exit penalty. You can withdraw them when you want. Plus unlike stocks or mutual funds, they do not fluctuate in value making it reliable to sell when in need.
Fixed Deposit for parking Emergency Fund
Alternately you can also park this money in a fixed deposit. FDs give about 6% interest and you will be able to dissolve the deposit and have your money in 2 working days or lesser. If you go this way, ensure your bank is not charging you any penalties for premature closure of the FD, or choose an option where there is none.
Backup to get money in 2 days or lesser
At this stage, I have an option to apply for personal loans and loan against the credit limit on my cards. I have ICICI bank, Axis Bank and several other cards that allow for this. They give me a short term loan 3 months to 36 months at an interest rate between 14% to 18%.
The other option is to tap into alternate lenders such as Moneytap, ET Money or Walnut Prime. These guys give personal loans on short duration. I have an open account with ET Money that gives me credit for Rs.2,00,000 which I can take up on short notice and need to pay back and pay interest on only the money I use. This can be a great back up option when in need.
Longer term- Money available in 3 days or more
I have about Rs.1,50,000 available to me on short notice. This takes care of my expenses for about 2 months tops in case of emergency and I can have this money in my account from seconds to less than 2 days. The remaining of my emergency funds are stored in diversified asset classes that I can mobilize quickly and will have it in my bank account as cash in 3 to 7 days max.
After having Rs.50,000 as cash and Rs.1,00,000 as Liquid funds, I am left with Rs.3,00,000. This is money which would cover about 2.5 months of my expenses. I am open to them having slight fluctuation in value and minor liquidity concerns. With the above 2 stages covering 1.5 months of my emergency crisis, that gives me enough time to take a decision on liquidating and keep this 1.85 lakhs ready.
Gold as an emergency fund
This is a personal opinion, as I believe gold is liquid, prices do fluctuate, but I am still comfortable with this movement at this point of time. Next year when I reassess my Emergecy fund portfolio, this may change. As of now, I have Rs.1,00,000 slotted in the form of digital gold which I can sell and have the money in my account in 4 to 7 days.
This will not give me any interest, but in terms of hedging my overall portfolio against inflation, providing diversification gold is a big help.
Loans given out
I have Rs.2,00,000 of loan given out to a close family friend. This is trustworthy person and I have an agreement to get this money on 30 days notice. I your case, treat this option with care as the person you lend to may or may not be able to give you this money on short notice.
I am confident of getting this money in 30 days as the person I have given this to has little need for this and has enough surplus to pay me. Had this not been the case, I would have re-allocated this money to the other categories mentioned above.