Jagoinvestor
May 31, 2012
Emergency Fund – Helps you stay in Action !
How many times have you ever faced an emergency situation in your financial life? I am talking about some situations when you needed cash within a few hours or days and it turned out that you had to seek monetary help from your relative for it or some friends, whom you didn’t want to ask?
Financial Planners and advisors suggest emergency funds to everyone saying that they should have it because there can be emergency situations in their life and they should always have a few month’s worths of expenses as plain cash for emergency purposes.
While it’s a good practice to maintain an emergency fund, a lot of people do not believe in it because for them emergency situation is something which will never happen to them. They always have fixed deposits which can be broken in hours/days and if its really required one can get it anytime. In the same way, mutual funds can be liquidated at a click nowadays and in the worst case, you always have relatives/parents etc who can lend you money in short term. So, in reality, a “real” emergency is really rare. This is how a lot of people think.
The real reason of having an emergency fund
But after a lot of introspection, I came to the conclusion that the real reason for having an emergency fund is something else. More than the “handling emergency situation”, It’s about your behavior about investing regularly. It’s helpful in stopping you from disturbing the investments which are all set in your life. Let me explain to you what I want to say with some examples.
Imagine a situation where you have started a SIP of 10,000 per month. You also have invested some amount in Fixed Deposits recently and few other investments. You all know that it’s damn tough to finally take actions and really start your SIP’s and actually make investments after a lot of thinking and analysis and “will surely do one day” thinking.
Now suppose you didn’t have an emergency fund, which is “6 months of expenses” for you. Now, what will be your natural reaction if you need money urgently? It’s very natural to break your FDs, liquidate your mutual fund’s investments and then say “let’s stop the SIP for few months till I am facing this cash crunch”. Put one hand on your heart and tell me, how many of us are really so dedicated to re-start our SIPs and investments after the situation is back to normal. We all get lost in our life and jobs and “problems” and then it only starts back after months and years of finding that perfect moment or if its “high time now” situation.
So as per my understanding, the real reason for having an emergency fund is to make sure that you do not disturb your investments which are already started and automated. The real reason for having it is so that you have dedicated funds which you will break before reaching out to your other goal-oriented investments. Think of it as a layer between your real wealth which you want to grow over the long term and money which you want to use in emergency situation. Think about this for a moment, its a little hard to imagine what I am saying here, but if you get my point, you will really appreciate the concept of this.
Did you understand what exactly Emergency fund does for your financial life?
Really interesting and very much useful. It all depends upon as to how one as actually uses it in his or her day to day practice with full dedication. Really great from practicle point of view…
Thanks for your appreciation
HDFC bank offers online FD, using your Netbanking account you can open/book term deposites anytime. It allows premature liquidation through online and you will also get sweep in facility. During emergency you can liquidate and amount credit to your SB account immediately. Premature liquidation charge of 1% in applicable.
I have 50K FD in HDFC bank and I maitain this as emergency fund.
Thats a nice way to maintain your emergency fund 🙂 .. The best part is that everything is online , so you can do things on the flash !
Hi,
Buying a Gold Coin as an emergency fund is also option for urgent need.
If you are sure you can sell it off in time of emergency , you are free to do so , but I am afraid to say that it does not happen in reality
For emergency fund, I have opened an current account and pledged 4 lakhs worth shares, which means I have a limit of 2 lakhs. Is this a good idea ? I am just making use of idle shares which I have bought for long term.
if thats what you want to do then its fine , but the value will be very volatile here .. are you sure you want to depend on that
One afterthought!
Six months worth expenses are generally suggested to be emergency fund. Why? Because should you lose your current source of earning, 4 months is considered to be reasonable time to start with something new. +2 months is buffer.
Have you noticed? Only one risk of ‘losing your job’ is being addressed here. What about money one would need to address source of other possible risks? Moreover it is not wise to tink that only one risk will materialize at a time.
I am certain I need much more than 6 months worth expenses. But this is provision of unknown. So for myself, the thumb rule is 12months worth expenses (NOT 12 month worth earning!)
Sarang
6 months is a good number for most of the people . This is a number you have to decide for yourself , 12 months is valid as per your situation and for some people they will say even 24 months is valid , some will say 2 months is good enough
I am back after very long time!
Risk Management is one of the most interesting subjects in management.
Emergency fund/budget consists of 2 basic constituents.
1) Mitigation fund : Amount reserved to deal with emergency situation. Actual expenses that may be incurred should some risk materialize. This is most commonly understood component to be emergency fund.
2) Contingency fund/budget : This is an amount reserved to cover for unknown risks. One must recognize that it is impossible to identify and manage all possible risks. So once in a while there would be some event that will throw away all your planning.
Some provision is required for such unknowns so that your planning & provisions for planned & managed risks does not get disturbed. That provision is Contingency fund/budget.
This artical is all about the 2nd component which is not commonly understood. Well done!
I hope readers remember that both these components are mandatory and they are NOT substitutes of each other.
Cheers!
Thanks Sarang and good that you contributed on this article comments section
Hi Manish,
One more thing I wanted to ask you is, Is it better to invest in MF,term insurance and accidental insurances through some financial institutions(I came across one whic has good service and they are charging 1% for MF SIP investment) or doing it personally? Please give your feed back.
Thank you,
Vishnu
Do it personallly , there is no reason to hire anyone . For mutual funds you can go with fundsindia.com who dont charge anything and its convinient as they are totally into online business.
Thanks a lot manish 🙂
Hi Manish,
Good inputs 🙂 I am reading your ” Jago investor” book now. You always speak power of compound interest of 10 to 12%. which investment can give me that? FD,MF, or anything else? Please guide me. Also I need to arrange roughly 5 lac amount in next 2 to 2.5 years. Which way of investing will help me for that? Please guide me.
Thank you,
Vishnu
Equities can give you 12% or more in long run, note that we are talking long term here and not just few years
Firstly i would like to thank Manish, as i never know of emergency fund prior to this.
I started building my emergency fund by starting recurring deposit. Intitially started with one RD of 500 rupees. Then stepped up slowly by adding another and another. This way it will not pinch you and also you do need to push into that fund immediately. Today along with my percentage in salary increment I add on new RD and thus maintain the limit of 6 months CTC instead of just expenses.
This way while breaking also instead of breaking all we only liquidate until necessary.
Though till date there was never a situation which made me break it though. Now and then when i had a problem i used credit card and repaid that with in the due date.
Thanks for sharing your case .
Very much thought provoking ideas Manish. I too had huge liquidity in anticipation of emergency which never occurred in the past 30 years.
Now if a person invests in FD and takes OD limit against the same(90%of the value of FD) and a single online operational channel in a Bank for SB and OD, abundant liquidity will be there. When ever emergency arise, transfer funds from your OD to SB in online and draw the cash by your ATM Card.
Yes .. thanks for sharing your views on this topic
Think about investments after emergency fund created. My idea is to, save 6months(6parts) expenses as emergency fund.
Put 1st Part in Bank Savings Account (Put this money in your second bank account, so that you won’t touch).
Put 2nd & 3rd in Liquid Fund (You can get money back within 24hrs).
Put 4th, 5th and 6th in FD.
After emergency fund created, take deep breath, follow “jagoinvestor” regularly, dream your financial goals, invest regularly, achieve them….be HAPPY….
Thanks for thinking like that 🙂
Thats too complicated as per me , why not 3 months in saving bank account preferable a second bank , and rest 3 in FD (online)
Hi Manish,
Just wanted to mention a point I do these days with my funds.SIP and direct stock investing money automatically gets transferred to a different bank every month without me even knowing about it[a fixed amount.
Now comes the FD/Emergency part. I have opened some of the FD’s for longer term and I don’t intend to touch them.With the remaining 3/6 months funds i.e emergency fund, I have created sort of a ladder system.It’s very easy nowadays to open FD’s online and takes about a minute maximum.I have broken the Emergency Fund amount into sort of 5/10 groups and they keep maturing[Short Term around 2/3 months] within 10 days of each other.The moment one matures I renew them again by spending a minute more online. Also I think one can use the sweep in facilities for this fund.
I understand if you have to go to bank to Open FD’s ,that would be a lot of work,but for internet savy people with Net Banking accounts it should be very easy.
Anindya,
Why to keep maturity period less? You will get less interest on 2-3 months one.Instead have for a period of 1-2 yrs in parts of 5 FDs.
I guess the emergency comes rarely and even it comes you can have the opportunity cost of liquidating the FD and loosing 1% interest on the amount.
If it does not come then you have the benefit of max interest.
Also having more FD makes things complicated and need to keep track of things.
As far as i think keeping simple things in finance will help a lot….
What you say manish…
Hi Suhas,
You are absolutely right that interest period is less for 2/3 months.But for emergency Fund I don’t go for longer terms as it helps me to keep my savings A/C balance to an absolute minimum like even 5K.This does not create much of a problem because FD s keep on maturing every 10 days or less.And this is only for the emergency Fund.
You are also right about the complexity first time,but till now I have not gone to my bank in a long time, all I do is to reopen the FD once I get SMS of my FD maturity and it hardly takes a minute.
Yea .. this laddering thing is very good 🙂 . Good one !
Hi Manish.. I agree to your point.
Can you please let me know how much should be the emergency fund?
Is it 5% of your total investment / Is it 3 times your monthly expense ?
Please suggest your thoughts
3-6 times of your monthly expenses is good
I have no hesitation in saying that Mr. Manish is always giving very practical solutions and suggestions for sound investments. Comments of your other fans are also very educational and serve as an eye opener. Thanks a lot to you and to all those who have given good feedback on your very useful article !
Thanks Subhash
Excellent Article, what I have seen in my discussions with my non finance friends is that the concept of Long term goal planning itself has become a mystical creature because of constant news programs saying different things about same basic concept,
I am not sure what is your conclusion here ?
Again an excellent article on neglected topic by many of us.
Manish, after this article your Best formula of Financial Planning viz
PPF+MF SIP+TERMPLAN+MEDICLAIM, needs a slight addition “EMERGENGY FUND.”
New Formula =PPF+MF SIP+TERMPLAN+MEDICLAIM+EMERGENCY-FUND!!
What Say….!! Thank you once again & other ppl for sharing various ways of making an emergency fund.
Yea you can say this is a common man’s financial plan , simple and effective
Hi Manish Chauhan,
This is a very good topic for Discussion. I think Linked FD is best one for parking the emenrgency fund.
Phani Kumar
Yea its a great choice i would say
I also agree for creation of emergency fund.There is a Saving-Plus account in SBI,which automatically sweep in the extra amount to fixed deposite.Which provides around 9% interest.And we can withdraw anytime with ATM.
Great .. thanks for confirming it
Hey this is a very good suggestion. Can you suggest where to invest money for the emergency fund and how much should I keep aside?
How much to keep is function of your job nature , your monthly expenses and what kind of other investments you have ? I would say 3 months expenses to 6 months should be considered as general rule
And where can I invest to maintain an emergency fund?
I keep it in Ultra Liquid Mutual funds where we get returns of FD but flexibility of Savings account.
Invest in anything from where you can get back your money asap. Typically if you liquidate your FD you get money the same day or next. For Mutual Fund it takes t+3 business days, which if it happens to be a weekend would mean a whole week. Hence I would suggest FD. If your bank has ‘FD with reinvestment on maturity’ that is even better where unless you withdraw your FD it will be invested.
Hey sundeep,
T+3 cycle is only for equity funds, In case of ultra liquids you get the money next day before evening. I use it quite frequently, in fact the first thing I do after receiving the salary is to trf. it out to Ultra Liq funds & then take a call about what to do with it…….
Thanks Siddhant. I never used Ultra Liq funds so wasn’t aware of it.
Charu,
If U have an account with ICICI bank, U might want to try ICICI Money Multiplier account. You can withdraw your money anytime with your ATM card or cheque. The interest you earn in this Acc is the regular FD interest. 🙂
http://www.icicibank.com/Personal-Banking/account-deposit/savings-account/moneymultiplier.html
Regards,
Arudra.
Nice Article. I agree that Emergency fund is the one which stops you from breaking those SIPs or Funds which you had planned for some goal. But you really do not know when you need the Emergency Fund, which is quite big amount (6 month expenses as said). Wouldn’t it be a good idea to put this fund into a FD or Debt Fund and liquidate it when in Emergency & also gaining better returns till they are not required
So “Emergency Fund” becomes another goal oriented investment (to use during Emergency).
This again concludes that there is no ‘real’ emergency for which you need to have 6 month of your expenses (near to 1 lakh) in liquid form earning 4% per annum.
Yes .. you can put your emergency fund in FD or anything , which can be broken asap .