All About Personal Emergency Fund

Whether you are a bachelor or have a family to take care of, everyone should have a Personal Emergency Fund. But tucking away some arbitrary amount of money under the mattress is not ideal for building up an Emergency Fund. And it is more about the mindset and less about the math. So in this article, we are going to discuss everything about Emergency Fund and why you should have one.

The importance of an Emergency Fund is realised only when an emergency arises. According to Money Under 30, 26% of all Americans do not have an Emergency Fund, and the percentage is much higher when considering India. This article was developed to spread awareness on why is it important to build an emergency fund and how easy it is to build an emergency fund.

What is a Personal Emergency Fund?

A Personal Emergency Fund is a lumpsum amount of money usually, three to six months of expenses, saved in a quickly liquid-able financial instrument like a saving account, to be used during uncertain times.

Let us elaborate the definition a bit more.

If you maintain a monthly budget (which you should), then you will have a very good idea about how much money you will need each month to make ends meet.

Now multiply that amount with the number of months you want to save for.

Let us understand with an example –

If your monthly expense is around Rs. 30,000/- and you want to have at least six months of expenses saved, then your Emergency Fund should have at least Rs. (30,000 x 6) =Rs. 1,80,000/-.

Now,

If you have never saved a penny before, then saving such a large amount might feel intimidating. And, if you start building up your fund with such a huge goal in front, then most probably you are going to give up in the middle. So we suggest you start small.

Set a small-easily attainable saving goal.

For example,

Try to save your first Rs. 1,000/-. And when you reach the goal, reward yourself.

A 2 AM ice-cream maybe! 🍦

Next, try to reach the 5,000 Rupees mark. And after that, the 10,000 Rupees mark.

This exercise will build the self-discipline needed to save such a lumpsum amount who have never saved before.

Momentum is also essential to save such a huge sum.

If you aim to save for a lakh, you might give up in the middle. But if the goal is smaller, there is a very high chance you will reach the goal, and it will also build up your self-confidence to achieve the next target.

Why is an Emergency Fund Important?

An Emergency Fund is one of the major pillars of financial security. It works as a safety net during any financial mishap in your life.

A very common scenario that can arrive in anyone’s life is an unexpected medical expense. And if a major part of the medical bill is not covered by the health insurance, you will have to cough up a lumpsum amount of money to cover the bill.

These kinds of situation can bend even the most financially disciplined person.

During such situations, to cover those unexpected expenses, people tend to take a hefty amount of unsecured debts like Personal Loan, Credit Card Debt, etc. And some people even fall victim to Loan Sharks.

And these kind of debts can destroy anyone’s financial health for life.

But if you maintain an Emergency Fund, such unexpected expenses will not be the cause of your nightmares.

People who realized the importance of an Emergency Fund are those who lost their job during the 2020 Pandemic.

Having three to six months of a financial buffer might have saved someone from sleeping empty stomach during one of the hardest battle for humanity in recent times.

An Emergency Fund will provide a financial cushion during the time of financial distress. Thicker the cushion, less hard the fall.

But you have to remember that an Emergency Fund is not for your leisure expenses, like buying the next iPhone or a home surround sound system.

You cannot touch the Emergency Fund even if you find a TV with a price tag of Rs. 1,00,000/- being sold for 30K Rupees.

Emergency Funds are not build to cover vacation expenses. It is only to be used when an actual emergency arises.

Now, the next question is –

Who Should Keep an Emergency Fund?

Any individual who has a regular stream of income should have an Emergency Fund.

It doesn’t matter whether you are a bachelor or have a family to take care of. If you are an earning individual, then you should have an Emergency Fund.

A single individual might need much less financial buffer than an individual who has some dependents. But still, every earning individual should have an Emergency Fund.

And if you have a family to take care of, then you DEFINITELY need a fully funded Emergency Fund.

A lot of Indian would rely on credit card even for a simple oil change for their car. Let alone a serious medical emergency or job loss.

So if you do not have a fully funded Emergency Fund, cut down a bit on your investment and try to fund the first thousand or five thousand rupees of your Emergency Fund.

If you are funding your Provident Fund account or you are saving in an ELSS to reach your annual 80C limit, then cover the Rs. 1,50,000/- of tax deduction using Insurance, Home Loan EMI Payments, etc. And try to aggressively fund your Emergency Fund.

Here is the list of all the investment avenues allowed under Section 80C for tax saving.

Once you have a fully funded Emergency Fund, then restore your money flow back into regular investment schemes.

You do not want to be in a situation where you have a few lakhs sitting in your PPF or EPF account while your home gets foreclosed because you couldn’t pay the Home Loan EMIs due to job loss.

When Should You Start Funding an Emergency Fund?

You should start funding an Emergency Fund immediately after you start earning or have a steady flow income.

After you start earning, the topmost priority should be having a fully funded Emergency Fund. Once you have a substantial amount in your Emergency Fund, then dip your feet into different kind of investments.

Here is a basic priority list of where your money should go once you have steady cashflow.

1. Emergency Fund
2. Insurance
3. Investments

But if you do not have any dependents, then keeping aside Insurance and focusing on Investments might be a good idea. But that is another topic for another day.

How Much Money Should You Keep in an Emergency Fund?

The value of your Emergency Fund should be your average monthly expenses multiplied by the number of months you want to save for. You should have a minimum of six months of expenses saved in your Emergency Fund.

Let us understand with an example –

On average, if you spend 50,000 Rupees each month, then the minimum amount your Emergency Fund should have is –

Rs. 50,000/- x 6 = Rs. 3,00,000/-

Or 3 Lakh Rupees.

While the COVID-19 distress had made some expert suggest that people should have at least a year of rainy-day savings at their disposal.

If you can build an Emergency Fund which will cover 8 to 12 months of expenses, well and good. But more than that 12 months is more or less redundant.

Personal finance expert Dave Ramsey says that everyone should have 3 to 6 months of expenses saved for an Emergency Fund. While Kevin O’Leary, a businessman and one of the hosts of the famous TV show Shark Tank, said in a Youtube video that he has 24 months or 2 years of expenses saved as an Emergency Fund.

We at Money Premier believe that 99% of the people don’t need 24 months of a financial buffer. 6 months is “OKAY” in most cases. But if you want to be extra careful, you can bump that up to 12 months.

But as said earlier, it might feel daunting to aim directly for the final amount.

Start building your fund with an easily achievable target like the first 1,000 Rupees or the first 5,000 Rupees. Then try to aim for the next reachable amount like 10,000 or 20,000 Rupees.

As they say, SLOW AND STEADY WINS THE RACE.

The more hurdle you will cross, the more confidence you will build to take the next challenge head-on. It will create the necessary momentum to build a fully funded Emergency Fund.

Where Should You Keep Your Emergency Fund?

You can use any high-interest saving account to save for your Emergency Fund. You should not use any savings or investment instrument where it hard to liquidate your savings into cash.

You shouldn’t keep your Emergency Fund in assets with low liquidity such as FDs, Mutual Funds, Stocks, Gold, etc.

Why?

Because you never know when an emergency is going to arise, and that is why you should always prioritise liquidity over returns.

Instant liquidity is what you should look for when assessing asset class to save your Emergency Fund.

Here is a list of High Interest Saving Accounts you can use to save your Emergency Fund.

Top 4 High-Interest Saving Account in India

1. Kotak 811
   Maintenance Charge – ZERO
   Interest on Balance – Up to 4% Per Annum
   Debit Card – Virtual Debit Card
   Online Transaction Features – Yes
2. IndusInd Bank Zero Balance Saving Account –
   Maintenance Charge – ZERO
   Interest on Balance – 6% Per Annum and 6.5% Per Annum on Auto Sweep feature
   Debit Card – Physical Debit Card (IndusInd Platinum Plus Debit Card)
   Online Transaction Features – Yes
3. Equitas Bank Saving Account (Selfe Savings) –
   Maintenance Charge – ZERO
   Interest on Balance – 7% Per Annum on balance above Rs. 1 Lakh up to Rs. 2 Crores
   Debit Card – Virtual Debit Card
   Online Transaction Features – Yes
4. NiyoX –
   Maintenance Charge – ZERO
   Interest on Balance – 7% Per Annum for Balance above Rs. 1 Lakh
   Debit Card – Physical Debit Card (Visa Platinum Debit Card)
   Online Transaction Features – Yes

Upstox, one of the premier discount stock broker in India, has partnered with IndusInd Bank to launch IndusStox 3-in-1 Account. The main aim of this account is to provide both banking and investment solutions to the customers.

We did an in-depth review of Upstox, and in that review, we have discussed in detail about IndusStox 3-in-1 Account. You can read the exact section by clicking here.

How to Earn Extra Interest on Emergency Fund?

If it is really painful for you to see idle cash sitting in a saving account then you can utilize something called Liquid Funds.

Liquid Fund is a kind of Debt Mutual Fund mostly used for parking idle cash. It is used as an alternative to a saving account that provided liquidity similar to a saving account while providing higher interest on the balance compared to a saving account.

Most of the Liquid Fund provide same-day liquidation. In some cases, it might take 24 to 48 hours to liquidate your Liquid Fund balance. Some Liquid Funds even provide ATM Card for direct cash withdrawl.

You can divide the total value of your Emergency Fund into 2 equal parts. One portion of the fund stays in the saving account while another portion goes into a Liquid Fund.

Let us understand it with an example –

If you have saved up Rs. 3 Lakhs as your Emergency Fund, then divide that amount into 2 equal parts.

That is,

Rs. 3,00,000 / 2 = Rs. 1,50,000/-

Now keep 1.50 Lakh Rupees in a High-Interest Saving Account and move the rest of the Rs. 1.50 Lakh in a Liquid Fund.

This way you can have the instant liquidity of a saving account while earning a little bit more interest than a saving account through a Liquid Fund.

But do remember that while your balance in a saving account is insured by DICGC up to Rs. 5 Lakhs, no such insurance is provided in a Liquid Fund.

And DO NOT follow this method if your Emergency Fund balance is below 1 Lakh Rupees.

We repeat,

DO NOT follow this method if the total value of your Emergency Fund is below Rs. 1 Lakh.

If the total balance of your Emergency Fund is below Rs. 1 Lakh then keep the whole balance in a high interest saving account.

You need to understand that your Emergency Fund is not an investment but insurance. Earning returns on the saved amount should not be your target. The reason behind building up an Emergency Fund is to protect yourself during an emergency.

An Emergency Fund will ensure that your financial health doesn’t degrade during any financial mishap.

That’s it.

We hope you liked this article about Personal Emergency Fund. Still, if you have any queries or questions, do let us know in the comment section, below. We will definitely try to answer it.

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As usual, in the end, we will say Good Luck and Happy Saving! 😊

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