Do I really need an emergency fund even if I have sufficient life and medical insurance cover?
I am glad you are thinking about an Emergency Fund, because a lot of people do not give it any consideration. However, you have made an assumption that emergencies are just medical. All emergencies are NOT medical. An Emergency is anything disruptive and out of the ordinary.
Your pet may need surgery. Terrible flooding or a cyclone may damage your house. Your air conditioner or refrigerator may break down during peak summer and you need a new one. Maybe the plumbing needs to be fixed in your house. There could be a death for which you have to suddenly travel. Or, it could be job loss.
When disruptive events occur, it is natural to get anxious and tense. The idea of having an Emergency Fund is so that you will not have to deal with monetary stress, in addition to the emotional turmoil you are already battling with. To the extent that you can provide a buffer, you must.
Here are my views.
- Relying on help from others is not a good strategy. Borrow from family or friends, and there is a cost to pay in terms of obligation and humiliation. Take a loan on your credit card or from the bank, you have a huge interest factor to contend with.
- Relying on your current investments is dangerous. What if the market is at a low when you have to sell your stocks or equity funds? You lose out big time. And, what will happen to your financial goals if you are going to deplete the money earmarked for them?
- The ideal amount can be anything between 6 to 12 months of living expenses.
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, visiting the pub, or eating out. Don’t include such spending. Focus only on the very basic costs—housing costs, utilities, and food.
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. Netflix. School fees. Tuition fees. 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.
A person with more dependents will need a larger fund. Even if you all live frugally, at the very least the grocery bill would be higher.
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.
So you have to use your discretion for anything between 6 to 12 months. 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.
- Slow and Steady. 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.
- Be practical. Finally, the money must be easily accessible, not only to you, but to your spouse or parents or dependents or children. 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?
Registered readers can post their queries by accessing the Ask Morningstar tab. Our team will answer SELECT queries relating to mutual funds, portfolio planning and personal finance. While we provide broad guidelines, we suggest you consult a financial adviser before making investment decisions.
ASK MORNINGSTAR archives
Articles authored by LARISSA FERNAND
