When Jet Airways shut shop, I was reminded of the need to have an emergency fund.
I personally know three pilots who were employed by that airline. Be it their designer attire, gastronomic indulgences, or holidaying across the globe, their lifestyle was the envy of many. When they lost their jobs, the carpet was rudely yanked from under their feet. Their households were running on their income. On top of that, one of them had EMIs to pay.
All along, people were convinced that the airline would pull through its financial woes. Few expected Jet Airways to collapse.
That is why, everyone MUST have an emergency fund.
I don’t restrict the need for one to just a job layoff. It could even be a health emergency. Even if you have medical insurance, you would need cash. Or a dental emergency – a visit to the dentist is neither pleasant, nor cheap. A devastating flood could damage your house severely. A death or accident of a family member may result in unexpected travel. A friend of mine had to make a trip abroad because her sister was going through a personal crisis and desperately needed emotional and moral support. She had no emergency fund and was planning on using her credit card. Eventually a family member lent her money.
Life is full of surprises; not all of them good. If you are living without a safety net, you are treading very cautiously.
How much should your emergency fund hold?
This is specifically for you to take a call. Generally, the thumb rule is 6 months’ living expenses. Now in case that intimidated you, hold on. The key term is “living expenses”.
The first thing that gets hacked, should you find yourself in a stressful financial condition, is spending socially. Avoid going for movies, hanging out at coffee shops or the pub, or eating out. Don’t include such spending. Focus only on the very basic costs—housing costs, utilities, and food. From that standpoint, amassing an emergency fund looks a lot more manageable.
Are you in debt? Servicing a home loan? Then include your equated monthly instalments, or EMIs.
Are you investing every single month, via a systematic investment plan, or SIP? Would you like to continue investing in spite of being unemployed? That would be a good idea.
What are the regular payments you have to make? List down every single expense. Cable. Netflix. School tuition fees and bus fees. Rent or monthly society outgoings. Gym fees. Electricity bill. Phone bill. Salaries of the house help. Insurance premiums – medical or life.
Then there are other expenses that are just plain-and-simple necessities – soap, shampoo, toothpaste, groceries… you get the drift.
How many dependents do you have? The more you have, it’s obvious that the larger must be your fund. Even if they all live frugally and with you, at the very least the grocery bill would be higher.
Are you the sole breadwinner? If there is another earning member in the family, focus on replacing the higher-income person, should he or she lose a job.
The greater your fixed expenses and the harder your job would be to replace (because it's specialized and/or higher-paying), the larger your emergency fund needs to be.
Where must you put this money?
Your best bet would be a bank fixed deposit or a liquid fund, preferably a combination of both.
At this juncture, the advice of Financial Coach and Investment Adviser Mahesh Mirpuri is invaluable.
He says that the money must be easily accessible, not only to the individual, but also to their spouse or dependents. If not, it defeats the very purpose of having such a fund. Imagine you meeting with an accident and in hospital, but the investment or fixed deposit is only in your name?
Mahesh also suggests an ultra short-term fund or a low-duration fund for a more sophisticated investor in the higher tax bracket.
Points to remember:
- An emergency can be emotionally very stressful. Don’t add financial stress to it. Be prepared, as far as possible. If you rely on your credit card to bail you out, you will have to deal with a very high interest rate and eventually land up in debt. Also, an emergency fund will prevent you from pulling out funds from your retirement account or selling your investments in a bad market. Neither will you have to borrow from family or friends.
- Never put returns as the prime factor of your emergency fund. Returns should be the least of your concerns. Instead, focus on easy accessibility of the money and its safety.
- Review your kitty once a year. The number of your dependents may increase; you may have another child or a parent may move 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.
- 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.
- Finally, you don’t have to build the emergency fund at one go. You can gradually build it up over months. But start now, if you don't have one.
Investment involves risk of loss