Saturday, July 12, 2008

Emergency Fund - A Burning Need

A few weeks back I mentioned that if you are among those people who have absolutely no clue what to do with your money, then a FA is really the best place to start. I stand corrected. A Financial Advisor would be the second best place to start. The first is an Emergency Fund.

The 'What'
Let's start with what is not an emergency fund. It's not some extra stashed awa
y money to be used to pay off your credit card bill or to be used to manage extra expenses during the month or buy a car or a new gadget or throw a party or to buy that Gucci bag! An emergency fund is to be used only in the case of an emergency - an emergency that threatens survival. It could be anything - loss of a job, accident, death, a loved one's emergency. In a culture like ours, we constantly depend on the cushion provided by the immediate family in case of emergencies. But haven't we heard of stories where families being hit by unexpected disasters have struggled to get up and start again. And what if the emergency was a threat to your immediate family and you were to provide that cushion? It's not that an emergency fund will provide solutions to the disaster but it will certainly help you manage your emergency better than if you didn't have the emergency fund.

The 'How Much'

There is no fixed thumb rule on how much is required or sufficient. While a number of books and websites suggest a back up of four months salary, an emergency fund should typically sustain you for at least six months. In the event of an emergency this money should provide for your basic living expenditure, continue paying off your EMIs, insurance premiums and take care of basic medical expenses that may pop up. How much is sufficient also depends on the number of dependents on the money. If you are married then your emergency money should cover expenses for at least six months for your spouse and you. If you have kids then include their expenses too. If you live with your parents/ relatives who depend on your income then don't forget to add them too.

The 'Where' Building an emergency fund may seem like an added burden in the beginning. The truth is that, it will bail you out of the real burden that awaits around the corner. If your budget is too tight to warrant any additional savings, then all the more reason to start an emergency fund. When you can't manage on a bright sunny day, it's going to be impossible on a rainy day. Consciously reduce expenses and set aside a certain amount of money (you can start with as low as Rs. 1000) to build your emergency fund. You can start by simply opening a savings account separate from your primary account.

When I tried to open an additional account with ICICI bank, I realized that the minimum quarterly balance to be maintained is Rs. 10,000. Now if you have even three such accounts this would mean that Rs. 30,000 would be blocked unnecessarily until you close the accounts. A way out of this is to open an account in a public sector bank like SBI where the minimum balance is Rs. 500 for a non-cheque operated account. Make this money as inaccessible as possible, so that you are tempted to use it only in the event of a dire emergency.

Another option that I personally find useful is Recurring Deposits. A recurring deposit will debit your account of a specified amount every month. Once you have built enough using a recurring deposit, move the money to another account or covert it to a medium term fixed deposit. If your bank (like mine) does not offer Recurring Deposits, then go for the option of a simple Fixed Deposit. Most banks these days allow customers to top up their fixed deposits by a minimum amount as and when required. When you've made up your mind to adopt the discipline of saving there will be no shortage in the number of ways you can do it. I know a few people who simply keep their emergency fund in an envelope in a safe and not so easily accessible place.

There are millions of articles on the internet and personal finance books that talk about emergency funds. The common thread that links them all is the stress on starting today and right away.

45 comments:

maduraiveeran said...

My Uncle always advises me to create an emergency fund and I am trying to. Good post! much needed for this generation of spending youngsters.

Arthi Madhusudhan said...

@maduraiveeran
Thanks for your comment. An emergency fund is one of those things you should never hope to learn through experience. I hope you manage to create your personal emergency fund soon. All the best!

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