Everything you need to know about Emergency fund
What is an emergency fund?
An emergency fund is a fund that you can rely on during times of crisis. It helps you tide over unplanned or unexpected financial situations. These can include sudden hospitalisation of self or a family member, job loss, temporary salary cut, a delay in your income or an additional regular medical expense, etc. In the absence of your steady income, your everyday expenses are not going to stop. So if your income stops for any reason, you can rely on the emergency fund.
Why Does One Need Emergency Fund?
An emergency fund is an essential asset that must be kept aside for crisis. It is a reserve that can be used in a crisis or for unanticipated and unplanned events rather than everyday expenses. Emergency reserves provide a financial cushion that allows us to stay afloat in a pinch without relying on credit cards or high-interest loans. If you have debt, having an emergency fund is crucial because it can help you avoid borrowing more. However, as a result, you must tailor it to address any unexpected financial gaps that may arise.
What is the amount that you should keep in an emergency fund?
The amount of money you should have in your emergency fund depends on your profession, whether you are salaried, professional, self-employed, or into business. Salaried people have a fixed cash inflow every month in the form of a monthly salary. So, for salaried people, personal finance experts recommend an emergency fund with 3-6 months of income. If both spouses are working, then an emergency fund with 3 months of income may suffice. If only one spouse is working, then an emergency fund with 6 months of income may be required. Also, suppose your company is not doing well or working in an industry such as airline, hospitality, etc., where sometimes salaries get delayed. In that case, an emergency fund worth 6 to 12 months of income is necessary.
In the case of professionals, self-employed, or into business, you don’t have a fixed cash inflow every month. Your cash inflows are lumpy, with some months bringing in high cash inflow, some months bringing in low cash inflow, and there may be some months when there is no cash inflow at all. So, with no certainty of cash inflow or the amount of cash inflow, in the case of professionals, self-employed, or into business, personal finance experts recommend a fund with 6 to 12 months of income.
For example, if your monthly income is Rs. 25,000 and you plan an emergency fund equivalent to 6 to 12 months of your income, your emergency fund should have Rs. 1,50,000 to Rs. 3,00,000.
Important note: All the above amounts mentioned are for salaried, professionals, self-employed and businessmen. These are just suggestions. Everybody’s financial situation and financial goals are different. Download the Glide Invest App and select the “Emergency Fund” goal and get step-by-step guidance on building your emergency fund.
While deciding on the monthly amount for your emergency fund, you should take the total of your family’s regular monthly expenses, ongoing loan EMIs, mutual fund systematic investment plan (SIPs), insurance premiums, school fees, etc. You can list down each line item in the order of priority and assign them weights accordingly. For example, line items like food, school fees, etc., are non-negotiable. Missing the payment of loan EMIs can lead to hefty penalties by the financial institution and badly impact your credit score. This can lead to difficulty in getting new loans in future. If you don’t pay the insurance premium on time, the policy will lapse, and if there is a claim on a lapsed policy, the insurance company can reject it. During a period of financial difficulty, you should pause your SIP's.
How to create and maintain an emergency fund?
If you already have an emergency fund, you should review it to check if you have sufficient money based on the above-discussed suggestions of personal finance experts. On the other hand, if you don’t have an emergency fund, then you should first decide on the amount that you need to have in your emergency fund depends on your profession.
Once you finalise the amount, you should start a systematic investment plan (SIP) in a liquid mutual fund scheme specifically to create an emergency fund. This fund should be earmarked as “Emergency Fund” and should be used only for that purpose.
Suppose you face difficulty in setting aside the SIP amount due to lack of funds. In that case, you should consider cutting down on certain discretionary expenses till you build the emergency fund. These discretionary expenses include:
- Dining out or ordering home delivery of food,
- Movies and other forms of entertainment,
- Vacation, etc.
You need not get disheartened as this cut in some of your discretionary expenses is only for a limited period till you build your emergency fund. While building this fund, transfer your lumpsum amounts to the emergency fund. Some of these lumpsum amounts may include:
- An annual bonus,
- Income tax refund,
- Any prize money,
- Cash received on occasions like birthday, anniversary, festivals, etc.
Building an emergency fund is crucial and the first step to your financial planning journey to accomplish your financial goals.. Hopefully, the economic hardships faced by you and other people you know during the Covid-19 pandemic would have already made you aware of the importance of this. Once you accumulate the required amount, you may stop the SIP and maintain the amount in the liquid mutual fund.
Every year, there will be an increase in your regular monthly expenses due to the impact of inflation, upgrade in your lifestyle, etc. Keeping this in mind, you should review the corpus regularly. Accordingly, you should increase the amount in your fund to match the increase in your regular monthly expenses.
Why keep your emergency fund money in a liquid mutual fund
When investing for emergencies, you should consider specific parameters:
- You should ensure the safety of capital.
- Funds should be easily accessible. You should be able to withdraw the money at any time. Also, once you put the withdrawal request, the funds should be available in your bank account in the shortest possible time.
- There should be liquidity.
You should be able to convert your emergency fund amount into cash without any loss of value or very little loss of value.
A liquid mutual fund ensures all the above three parameters, and hence you should invest your emergency fund money in a liquid mutual fund. In addition, liquid mutual funds have the potential to give better returns than a savings bank account.
Where To Invest In An Emergency Fund?
Emergency money shouldn’t be left exclusively in cash or in a bank account once it is accumulated. Even while an emergency fund should be liquid, it should not be used frequently. As a result, invest it in such a way that we get decent returns without sacrificing liquidity. Spreading the emergency fund across liquid funds, short-term RDs, and debt mutual funds is the best option.
Redemption of Emergency Fund
Many liquid funds provide instant redemption of up to Rs.50,000, or 90 per cent of the invested amount, in terms of liquidity. You have the option to redeem at any moment. They will immediately credit the funds to your associated bank account. Before you invest in a liquid fund, be sure the fund house permits immediate redemption. This way, you can secure quick access to your emergency cash while earning excellent returns by dispersing it over several avenues.
Insta redemption facility from Glide Invest
You can do your emergency fund goal planning through the Glide Invest App. It will be invested in ICICI Prudential Liquid Fund – Direct Plan-Growth. The scheme invests in debt and money market securities with a maturity of up to a maximum of 91 days. The scheme aims to provide reasonable returns with low risk and a high level of liquidity.
The biggest USP of this mutual fund scheme is the insta-redemption facility available to Glide Invest members when they invest in an emergency fund. With the insta-redemption facility, you can withdraw up to Rs. 50,000 or 90% of your invested balance, whichever is lower, on any given day through the IMPS facility. The money will be credited to your bank account within 30 minutes.
If you wish to withdraw more than the maximum limit (Rs. 50,000 or 90% of your invested balance), you will have to go through a normal withdrawal process. Then, the money will be credited to your bank account in 1-2 working days, depending on the cut-off time of your redemption request.
When it comes to saving, it's crucial to establish a line between emergencies and everything else. In reality, after we've reached a fair level of emergency savings, it's a good idea to start separate savings account for unforeseeable but unavoidable events. Many banks allow consumers to create and identify sub-accounts for different financial goals if they need help staying organised.
Everyone should put money aside for the unexpected. Having a cash reserve can mean the difference between surviving a financial crisis and sinking further into debt.
Q1: What needs to be done with an emergency fund?
A1: A cash reserve set aside for unexpected bills or financial emergencies is known as an emergency fund. Car repairs, home repairs, medical expenditures, and a loss of income are all classic instances.
Q2: How much money should you put aside in case of an emergency?
A2: While the size of your emergency fund will vary based on your lifestyle, monthly spending, income, and dependents, the general rule is to set aside three to six months' worth of expenses.
Q3: What should not be done with an emergency fund?
A3: This means you shouldn't utilise your emergency fund for the following things: For a house or a car, a down payment is required. Costs of starting a business. Early retirement is a good thing.
Q4: How can I figure out how much money I'll need in an emergency?
A4: Individuals should have enough in an emergency fund to cover three to six months of living expenditures, according to the rule of thumb. Add up all of your basic living costs for one month and multiply by three or six (depending on how much you're comfortable having in case of emergency).
Q5: What is the best way to create an emergency fund?
A5: Simple way to create an emergency fund is:
- Make a budget and figure out where you can save more money.
- Establish a target for your emergency money.
- Create a direct deposit account.
- Increase your savings gradually.
- Save money that comes in unexpectedly.
- After you've reached your goal, keep saving.
- Take advantage of a bank account incentive to get a head start on your savings.