4 questions on Emergency Funds answered

By Larissa Fernand |  07-09-20 | 
 

What do you do when life throws you a curveball? Or bowls you a googly? Note, I use the word “when” and not “if”. Because the unexpected takes place. The unpleasant does occur. Stuff happens. And yet, the bills and payments never stop.

When Jet Airways shut down, I knew a few individuals who were suddenly left unemployed. That was when I began to take the concept of an emergency fund very seriously. This pandemic, I have seen so many extremely stressed about their monetary situation, in addition to worrying about the health of their babies or ailing parents.

Now, I cannot stop yelling from the roof-tops on the need for an emergency fund.

WHY: Why do I need an emergency fund when I can access money easily?

When disruptive events occur, it is natural to get anxious and tense. Often, there is nothing we can do to prepare for it. To some extent we can provide buffers. Life insurance will help cushion the blow from losing a bread winner. Medical insurance will cover up huge bills. The idea of having an emergency fund is so that you will not have to deal with monetary stress, in addition to the emotional turmoil you are already battling with.

There are other avenues you can explore to source funds, but they will cost you dearly in the future.

  • A personal loan from the bank or the use of your credit card carries a stiff interest rate. Why add to your financial woes?
  • You can dip into your provident fund or sell investments from your child’s education fund or your retirement kitty. But these must be sources of last resort. After all, that money is being saved for a very specific and real purpose. And if you pull out of it, those goals will be in jeopardy.
  • If you depend on your investments to bail you out, you may be forced to sell your equity funds or stocks when the market is in the doldrums. (see below on where to invest your emergency fund).
  • Borrowing from family or friends has its own share of humiliation and obligation. And eventually, all these loans have to be squared off. The absolutely last thing you should be doing is getting into debt.

WHAT: What must be the amount?

There must be no generalizations or cloning of someone else’s calculation. Put in the hard work to come up with a number customized to your life. Depending on whether other family members are employed, you can look at 6 to 12 months of living expenses. If it is a one-income household, you need to have a very substantial fund. Also, if you are self-employed, it is better to err on the side of caution and go for a bigger number since the comfort of a regular salary is not a given and you are more susceptible to dry spells.

The emergency fund covers basic expenses, not lifestyle costs.

  • Roof over your head: rent, monthly society outgoings, groceries, electricity bill, water bill, medication, wi-fi, cable (Netflix, Amazon Prime, Hotstar)
  • Loan payments (EMIs)
  • Salaries: driver, house help
  • Fees: school, tuition, other activities like music or dance or yoga classes
  • Annual payments: premiums towards health and life insurance, gym membership

If you can truly afford it, it would be good if you even budget for your systematic investments in funds, though you can be flexible on this.

As is evident, there is a lot of customization and personalization around the exact figure that should go into an emergency fund. But try to get as accurate as possible. It must be a concrete goal.

In case you find this accumulating to a lot, there is no need to get demoralized. You do not have to build this overnight. You can do so over months.

WHERE: Where must I invest it?

When it comes to your emergency fund, do NOT chase returns. Your focus must ONLY be liquidity and safety.

A lot of individuals prefer a bank fixed deposit because of the assurance of safety.

But emergencies, by nature, do not occur frequently. One may not have to dip into this kitty for years on end. So, if you are looking at a vehicle that generates a better post-tax return, you could also consider a liquid or even an ultra short term fund.

Liquid funds primarily invest in money market instruments like commercial paper (CP), treasury bill (T-bill) and certificate of deposit (CD) with a low maturity period. Ultra short term funds primarily invest in liquid fixed income securities which have short-term maturities.

Your emergency fund need not be just one investment. It could be a combination of the above.

This money MUST be easily accessible to other family members too. If you meet with an accident or are hospitalized, and your family cannot access this money, the entire purpose is defeated.

WHEN: When must I use it?

If you have an emergency fund, you have earned the right to use it. Here’s when you can dip into it with absolutely no feelings of guilt.

  • Loss of employment

This is the prime reason. How will you pay your basic bills (rent, food, school fees, electricity bill) if you have no money coming in? Once your cash flow decreases or stops, you need some cushion to fall back on till you get a new job or assignment.

  • Travel

A friend once had to rush to another country to be with her sister who was having a very bad spell in her marriage and desperately needed emotional support from family. My friend was going to use her credit card to pay for the trip. Fortunately, a family member gave her an interest-free loan to be repaid whenever she could. Another friend had to borrow money to book last-minute air tickets and accommodation to attend the final rites of family members. Travel may be called for due to various emergencies – death and illness being the most common.

  • Healthcare

Accidents. Illnesses. Dental emergencies. This could be for any family member or even a pet.

In case you consider facials, botox, pedicures, beauty treatments, or LASIK surgery, as crucial, I suggest you give this careful consideration. They can wait and do not provide a sufficient reason to tap into your emergency fund.

  • Repairs

Car. Bike. Appliances. Home.

Use your discretion on whether you need to get your vehicle repaired. It would depend on how much you and your family rely on it and the public transportation where you reside.

If your refrigerator is broken, you need to fix that immediately. If your dishwasher breaks, you should consider whether you really need to dip into your emergency fund.

If your house needs painting, it can wait. But tremendous leakage or a clogged kitchen sink would have to be attended to.

Final note

Don’t forget to replenish the emergency fund if you deplete it.

It would be wise to periodically revisit this number. You may have budgeted for dependent parents who have passed away. Alternatively, the number of your dependents may increase; you may have had a child or a parent may have moved in. Your spouse may have given up her job to be a home maker or start a new business. You may have taken on some debt.

Investment Involves Risk of Loss.

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ninan joseph
Sep 8 2020 05:29 PM
 Fully agree with what the author has written. In fact, this fund should be in a FD - of a Bank and nothing else. If you have tax issue give 15G form and TDS will not be deducted. As the topic is on Emergency Fund, it is not OK to have only a Medical Insurance, each one, should earmark a small amount and put it in a Recurring Deposit. This is needed as not everything is covered my medical insurance, there are so many other expenses which remain uncovered. To cover this you need to have it. The strategy for younger people is
1. Start a Recurring deposit of a small amount. God willing, this amount will not be used.
2. Once the RD matures, you can place this capital as a FD with quarterly interest to be credited to the account.
3. You can use the quarterly interest for buying medicines which is not generally covered by insurance.
4. You should then approach the bank where the FD is placed and ask them for an OD against this specific deposit. This is because in case of any contingency or emergency, you can temporily use the OD. But remember it should never be used for anything else.

By doing this you are completely covering medical emergency and at the same time making provision for buying medicines. As you grow older you are bound to get lifestyle disease such as BP, Diabetes - These medicines need to be bought. You can use the interest from this fund.

For people who are no longer young, you need to earmark one of your FD of say 5 lacks or 10 lacks based on your need. Earmark this and treat this as not part of your networth - so that you wont eye it in case other need. Also take an OD against this for contingency.

Man proposes - God Disposes - Let us do whatever we can - in the end everything is in the hands of God.
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