The why and how of an Emergency fund

One of the first things that you would have heard financial advisers and many other well wishers articulate, is the need to have an emergency fund. In the older days it was common to see families stash some cash in their house to guard against any sudden money  need that might arise. Fortunately in today’s context, when the accessibility of your money is much easier, you do not need to do so.

First things first – what is an Emergency fund? Well it is an amount of money that is accessible to you quickly in the event of an emergency situation. This could be a sudden hospitalization need in the middle of the night, a travel undertaken with no notice, a need to help out a relative or neighbor with some cash money etc. The amount needed is difficult to predict but typically, it will be a certain sum needed right now and then the rest of the amount needed in a day or so.

So do you need an Emergency fund? Absolutely yes – even though we can try our best not to reach an emergency situation, this is really not in our control. Unexpected things can happen, it is the best option to be prepared for it. For example, you may have Health insurance with cashless facility in several hospitals, but may be forced to go to a hospital that is not with this facility in the middle of the night. It could even be for more mundane situations like your salary having got delayed and you needing to pay the EMI on a particular date. If you are in your own profession and depend on cash inflows in form of paid Client invoices, these short term emergencies can be irritatingly common occurrences.

How much should you plan for an Emergency fund? Well, if the issue is with mismatched cash flows for your business then the amounts may have to be quite high, sometimes in the range of 5-7 lacs, but these can be tackled as exceptions. For most normal situations an amount of 2 lacs or so should suffice. Remember, you are looking at money that you need to access immediately, not the total expense that may need to be incurred. So the hospital expenses, in case of an accident could total 5 lacs but to get yourself or a family member admitted, you’ll probably need 1-2 lacs even in a pessimistic scenario.

Here is how I would advise people to go about creating an emergency money availability:-

  1. Cash – always make sure you have around 10,000 Rs available at home, without having to go to an ATM.
  2. Money in SB Account – have about 50,000 Rs to 1 lac available totally in the accounts of you and your spouse.
  3. Credit card – have multiple credit cards ( without paying any joining or Annual fees ) as they can be used in most places dealing with an emergency. It can also be used to withdraw cash, though at very high rates of interest.
  4. Liquid financial instruments – these can be Liquid MF or similar instruments that can be redeemed within a day.
  5. Forex – if you have traveled abroad recently, you may have some foreign currency with you at home.Exchange this when you need cash. It is actually easier to keep 300 $, as opposed to 18000 Rs.
  6. Pooling with relatives / friends – you can arrange with them informally so that you can access cash from each other in case of a sudden unexpected need arising.

From the perspective of emergencies being caused out of cash flow mismatches, the best way will be to have a current account with adequate overdraft facilities to take care of such situations.

While I wish none of us have a need of such funds ever, it will be important to plan for it to give us peace of mind.

Remember, an Emergency fund is very different from a Contingency fund, which we will tackle in the next post.

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