Building An Emergency Fund In Effective Way

There are three major risks to life, viz., death, disease and disability. All the three Ds could be covered or protected against by adequate insurance. Similarly, for perils on our vehicle, house and even business establishment, etc. there’re insurance solutions to opt for

The one critical but mostly ignored aspect of financial planning by investors and advisors is the provision of emergency fund. While everyone agrees the need for it, very few have a proper plan to ensure the availability. This is because of the lack of clarity or definitive solution to arrive at the size or quantum of the fund. True, like any financial plan, the emergency fund is also personal and not standard.

Life is always dynamic and despite whatever or however we may plan, there could always be surprises, not all being pleasant. An emergency fund could partly address this. An emergency fund is a reserve capital that’s easily accessible to tide over life’s unpredictable expenses or financial emergencies. It provides a cushion so that the planned budget isn’t upset due to these unforeseen circumstances. Why would we need?

There are three major risks to life, viz., death, disease and disability. All the three Ds could be covered or protected against by adequate insurance. Similarly, for perils on our vehicle, house and even business establishment, etc. there’re insurance solutions to opt for. At times, there are unannounced emergencies that could arise like that of sudden change of job or even unemployment (for a short period), major repairs to car or home that couldn’t be covered under the regular insurance, etc. These unannounced expenses could be a source of distress, at times in the short-term.

Having a reserve could help sail over these disturbances while allowing one to settle and address the day-to-day life (budget) thus stabilising the situation. An emergency fund hence works as a safety net for such unprepared events and/or circumstances. The foremost requirement of emergency fund is the liquidity or availability of these funds at an almost immediate notice.

Now, how much quantum should the emergency fund be, this is highly subjective and should be arrived at depending upon the individual’s choices. If one is part of a volatile work environment, then the need for emergency fund is highly imperative. The back-of-the-palm calculations usually range from three to six months. Some individuals however prefer a particular amount or even a year’s corpus (possible earnings). None of this inaccurate as I’d already mentioned the decision is personal.

Once the tenure and thus the sum is decided, the nature of the fund must be decided. These vary among individuals and where they domicile, especially the longer period of buffer is planned the more efficient they should be. The ideal situation looks like holding cash or equivalents like in savings account. This could be ideally not exceeding one-month of the budget, though could stretch a bit. If the emergency fund provisions more than two months of the budget, then one could consider a sweep-in accounts or other similar options.

These’re accounts where the money is moved to a fixed deposit automatically beyond a threshold so that they could earn a higher interest than in the savings account. One could also consider moving to a bank fixed deposit or term-deposit by giving an auto-instruction to move the fund so that it at least remains with an access restriction. This is important because the idea of emergency fund is not just to park money aside but also hinder one from making impulse spending decisions. If the tenure is higher than four/five months, one is better off considering liquid or ultra-short funds to park the money. This allows for productive use of reserves which could earn a higher return though the access here is restricted, as it needs at least one working day to receive them to the bank. Some investors look at gold, may be to a portion, but wouldn’t recommend due to the price volatility, it could be either of physical or digital, though.

Another mode, I personally prefer, is to ascertain a credit card higher limit but to be used only for this purpose. Like I earlier mentioned, this is helpful in urban areas where the card transactions are prevalent but nevertheless enjoy the access to emergencies without needing to worry to accumulate for them. However, one needs to have a clear plan to clear off the debt within the timelines so this could act auxiliary to the debt funds.

An ideal way to build for emergency is to have a structure to provide through all these forms so that there’s an efficient way to handle the cash while bolstering against the exigencies. Of course, budgeting is vital for arriving and managing an emergency fund. Once the quantum is decided, initially one could begin slow and derive over a fixed time and then use the above structure to manage over time. Remember, the size of the fund changes over time as the lifestyle expenses increase.

(The author is a co-founder of “Wealocity”, a wealth management firm and could be reached at [email protected])