Finance

How to build an emergency fund? Why to have it?

In what context have you heard the word emergency? Emergency landings? Emergency wards in Hospitals? State of Emergency declared in a country? What are the cohorts between all these examples?

(1) The situation being described is definitely unwanted.

(2) It is unprecedented and probably caught the people involved, off guard.

(3) There’s a sense of panic involved in every example.

(4) Uncertainty is at its peak in such a condition. You don’t know how long is it going to be there.

Today, we discuss one such catastrophe that may pop out like Bin Bulaye Mehmaan (Unwanted Guests) in our lives. This is called a financial emergency and you can circumvent it through something called “Emergency Fund”. An emergency fund is an essential corpus that you must keep aside to tackle emergencies. Still not convinced? Let’s explore why one needs an emergency fund at all:

Why do you need an Emergency Fund?

So one may ask, that I have life cover, a health insurance from the company I work for or otherwise. So why does one need an emergency fund at all? What other emergency is expected? My mother always says, “Dikkat bata kar nahi aati” (Troubles don’t intimate you before arriving).

Think of the situation all of us were in recently. Coronavirus led to job loss for so many people and salary cuts for even more. What do you do in such a situation? There is no insurance covering this.

God forbids, if you meet with an accident and are rendered unfit to work for a while, what happens in that case? In such a circumstance, you may need at least 3 odd months to recover. Who is going to take care of your expenses during that period?

Emergency Fund

Assuming that you have taken the best health cover but the situation demands that you pay upfront and later get your claim amount. Next month’s rent/EMI is due in next 5 days. Are you expecting your family to be with you in this moment of shock or you want them to arrange money for paying the rent/EMI?

While above examples are dark and may give you jitters, but you still can’t run away from them. Therefore, any financial planning should begin with the building of an emergency fund. Once you have this fund and insurance is place, then only it makes sense to start investing. Else, your lifetime savings can vanish in a trice in these cases.

Why Emergency Fund

Isn’t Credit Card supposed to cover exactly that?

I grew up learning that debt is bad. Credit cards are evil and one must use them only in case of emergency. Since then, I relied on credit cards for my emergency fund and never bothered to set aside some cash for my rainy days. However, one must realize that emergencies don’t come up with a fixed duration. Therefore thinking that you’ll be able to repay CC debt after the situation normalizes is plain naïve.

Credit cards as emergency fund

Credit card loans are the most expensive loans one can accrue. Therefore, while credit cards will help you mitigate the immediate impact of an emergency, you still have to pay them back. And unless you have that plan of action in mind, your credit card won’t rescue you.

How to Start Building an Emergency Fund?

But you are never accounted for this? How do you start? In my opinion, it is the hardest fund to gather. A highly liquid source of money is right in front of your eyes. How do you NOT use it? Here are some tips and tricks that I followed to embark on this journey:

1. Cut Down on your expenses:

I know its tough to resist that new Shirt/Top from Zara, or may be eating out in that lavish restaurant that just opened next door but expenses have to be cut down in order to save. You may have to question every expenditure you are making out of budget.

Cut down expenses

Sleeping over a purchase decision is an extremely useful technique to segregate between impulse and actual needs. Here are some additional ways that can help you squeeze out that extra money:

1.1 Subscriptions:

OTT platforms are addictive. But do you really need all of them? Can you live off with only a couple of them? You need to ask these questions before blindly subscribing to the likes of Netflix, Amazon Prime, SonyLiv, Voot etc. Apart from that, never set up auto pay for these subscriptions. This will force you to interrogate your conscience each month. Along with that, do you still need cable TV after all this? That is a straight saving of about Rs. 400 if you don’t. With cricket matches and news being online, I don’t think cable TV is required any more. You call the shots.

Also, gym subscription? Do you really need it? Of course you do. But do you actually use it? A tough one right? I’d leave it to you.

OTT

1.2 Eating Out and Food Deliveries:

Guilty 🙋. I am trying to cut down on this expense ever since. If you evaluate closely, a meal in a restaurant for two would cost you about Rs. 1500. Now take this amount and check how many days worth of home cooked meals you can have with this money. I am sure it’ll be somewhere around 7 days (21 meals). So, you take a call. I am not asking you to never go out. But set up a limit. Try to revise it downwards every month.

Eating out

Likewise, if you are really not in a mood to cook and want to order from outside, a sensible option would be to pickup your food instead of using Swiggy and Zomato. The food prices in the menu of these apps are already inflated. Above that you have to pay hefty delivery charges. So, either seek an alternative where the restaurant can directly deliver it to you without foodtech involved OR pick it up yourself.

1.3 Budgeting

Nothing new here. But yet, this is hardly followed by households these days. Not only you should prepare a charter of all the monthly expenses, you should look out for opportunities to curtail. The harder part? Sticking to it. Most of us get carried away in the middle of the month, say those magical words (F*** it) and start spending like kings.

Budgeting

My wife often accuses me of this, and I have observed it as well: Whenever I mix money with emotions, I often end up being screwed for the months to come. So, please don’t get too Jazbaati (Emotional) when it comes to expenses.

2. Start Over Each Month:

If you have managed to save some money in the end of the month, don’t let it sit in your daily transaction account for the next month as well. Transfer it to a separate account. This way, you do not spend recklessly thinking that there’s enough cash in hand. This saved money, no matter how small, can contribute to your emergency fund.

3. Earn More:

Yes, you read it right. Earn more to save more. Try to create multiple streams of revenue for yourself. It’s okay even if they aren’t remotely related. Our beloved Elon created Paypal, Tesla, Space X, Hyperloop. Are these businesses even remotely connected? Amazon is into retail, online market place and cloud services.

Side hustle

So stop thinking and leverage your skill set and try to monetize it. Played an instrument as a kid? Time to polish that and look out for gigs. Good at math? Start taking tuitions. Don’t have any monetizable skill? Learn one.

With Meesho, Fiverr crawling into our lives, opportunities are just endless. Simply watch out.

Where to Park the Emergency Fund?

Now that you have decided to set aside that fund, where do you store it? In the form of cash? In bank account? Let’s understand the pros and cons of each of this method.

1. Cash:

Cash is a highly liquid asset. Good thing is that it is available to you immediately in the need of the hour. However, there are more downsides than upsides of parking your emergency funds using this mode.

Cash

A. Security: Physical cash is always at risk of being stolen, damaged.

B. Rate of Interest: Since you are earning ZERO interest on the cash in hand, you are actually growing poorer by the day. Your effective interest (Interest – Inflation rate) is negative in this case.

2. Bank Deposit:

Again a liquid asset, a quick access to your money. This time, you are also earning a rate of interest of about 2.5%-3.5%. However, this is also less than inflation rate of average 5%.

3. FDs and RDs:

FDs and RDs will most likely be able to beat the inflation by a small margin. However, there are some factors that you must consider while parking funds here.

A. Exit Load: In case you have done a FD/RD of one year, and emergency strikes in 6 months (say), there’ll be an exit load of 1% on the withdrawal. This would bring down your return lower than inflation.

B. Taxation: Gains on FDs and RDs attract a tax on the basis of your income slab. So once you plan to withdraw it, you need to revisit your tax planning.

4. Liquid Funds:

Liquid funds are low risk mutual funds that are able to give you a return of about 7% p.a. Apart from that as the name suggests, they are highly liquid. In most cases, you will get your parked money within a day. In most cases, the exit load is applicable only till 1 month in liquid funds.

Now What?

Disclaimer: This is not a financial advice or tip. Please consult your financial advisor or do your research before investing.

I tend to diversify my emergency fund as well. I put 60% of the money in the liquid funds (I personally use Nippon India Liquid Fund). 20% of my money is put in an FD and the remaining 20% is sitting idle in my bank account. This bank account doesn’t have net banking or UPI activated on purpose. Apart from that, the debit card for this account is kept in my almirah and don’t carry it along with me.

Diversify

In the need of the hour, bank account will be touched first, then I would jump to liquid funds and later go to FDs if need be.

This way, in case of an emergency, I am able to withdraw funds in tranches without any serious tax implications or exit load.

Conclusion:

While creation of an emergency fund is one of the most important aspects of personal finance, it is often overlooked. As a thumb rule, if you are single, a 3-month emergency fund is a must have. This goes up to 6 months for married people. I started creation of this fund about an year ago and till date I have managed to save about two month’s worth of expenses. My goal is to take it up to 6 months by my next birthday using all the methods I have mentioned above.

What are your thoughts on emergency fund? Do you have one?

Let me know in the comments section below. Hit me up on FacebookTwitter or Instagram. If you find this article interesting, please consider sharing it on social media using the links below:

Until Next Time. . .

rgvdudeja
A techno manager by profession and a hardcore geek at heart. I love to poke my nose into tasks where other usually gave up on. My hobbies include, reading about latest trends in tech industry, playing guitar and yes, memes!
http://pandatechiein.wordpress.com

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