What is Emergency Fund & How to create?

April 19, 2013

The word emergency strikes siren in our minds. For us emergency means just one thing- an accident, disaster etc. On a second thought, can there be an emergency fund in our financial plan? Since money would be needed to resolve any emergency- there is requirement of an emergency fund. Many of us would think that there is no need of a separate emergency fund because in case of emergency we may simply redeem some of our investments. One may even say that since we have mediclaim, why do we need an emergency fund at all? The hospital charges will be met by the insurance company Let Us First Understand What Is An Emergency Fund? An emergency fund is a corpus which will be used to meet expenses related to some unforeseen events of life. Those unforeseen events may be some accident, bankruptcy of a major debtor, theft or burglary, Income tax raids etc. So emergency cannot only be in the form of some accident- there can be other emergencies too which insurance does not covers. The primary aim to have emergency money is to avoid financial hassles during times of distress. Although money cannot fulfill mental or emotional losses but it can somehow limit our stress. Further, an emergency fund would always protect our long term financial plan from getting distorted as you would not redeem your investments if you have a separate emergency fund. And most importantly, an emergency fund would boost our confidence that we are prepared for the worst! When Emergency Fund Is To Be Utilized? 1. 2. 3. 4. 5. 6. Medical emergencies if your insurance policies do not have cashless provision. Financial emergencies like replacement of home in case of natural disaster. Income emergencies like loss of job or slowdown in profession for cyclic reasons. Household emergencies like expenses required for some repairs or replacements of assets. Emergencies of your friend or relative who may call you up for support. Availing some random offers which can save money in future like lower interest payments or special benefits.

If you follow a monthly expense plan, an emergency fund can also be used to help stabilizing your monthly budget if your overshot a particular expense in any month. How Much Emergency Fund Is Required? There is a lot of dilemma as to how much should be the emergency fund? Should be for 6/9/12 months! However, I do not believe this is a difficult question at all. We very well know our financial situation- which is the primary factor in deciding an emergency corpus. No financial advisor/ calculator/ model would be able to understand our financial situation better than ourselves. Thus, no one else can accurately decide an emergency corpus for us than ourselves. Yet, for convenience, there are some standards of keeping 6 months expense as emergency corpus. We say it in terms of monthly expenses because household expenses are very easy to calculate and this is the only traditional method being followed by our grannies (they used to hide some monies into rice containers/beneath the bed etc.) One should keep a reasonable amount in emergency fund- a very small corpus may put you in distress while a huge emergency corpus may cost you in terms of lower returns. Let us look at some factors which might help you in deciding the emergency corpus: If you are the sole bread earner of your family and you do not have any alternative source of income- then you should maintain at least 12 months monthly expenses in your emergency account. Secondly, if you have some EMIs running on your account- than along with the 12 months expense you should also add 6 months of EMIs to your emergency corpus. If there are more than one earning members in your family- than you may keep 9 months of monthly expenses in you emergency fund.

What is Emergency Fund & How to create?

April 19, 2013

While deciding the emergency corpus you should also consider the following factors: Number of disabled members in your family Members suffering from severe diseases and their regular medical expenses

Your Credit Card Is Not an Emergency Fund

This is the worst excuse to refuse from creating an emergency fund. Your credit card in NOT your emergency fund, so do not comfort yourself with huge credit limits on cards. The cash or credit drawn on your card is a loan and the most costly loan. An emergency fund is created to help you in times of distress and not to put you under a heap of interest payments for the rest of your life. You do not know when an emergency strikes and how much it can cost you in terms of monies and time to revive. In those times you need your own money to bring you out of the agony.

How to Create an Emergency Fund and Where to Keep the Emergency Corpus? After you decide the emergency corpus- the next step is to put it in functional mode. So where should you keep the emergency fund- in rice containers? Or under the bed? I know youre smiling The steps to create an emergency fund are: 1. Do not put entire emergency corpus in one place- divide it between Cash, Savings Bank Account & Liquid Mutual Fund. The monies can be kept in the ratio of 20:30:50 i.e. 20% in cash, 30% in Savings A/c and 50% in liquid mutual funds. Liquid mutual funds are pretty safe and can be redeemed within 2 days. Open a separate savings account with bank and designate this account as emergency fund. You can transfer monies in this fund every month until the desired level is reached. See that you have the ATM card facility, e-banking facility etc. with this account. Deposit some money in any liquid mutual fund. Do not think much in terms of selecting the best fund- because all liquid funds offer similar returns and safety of capital. Simply select a 4/5 star rated fund from Morningstar or valueresearch. Do not forget to register your email id, mobile number and avail online facility in this mutual fund. The online facility would allow you to redeem your money without completing any paper work. Some fund houses also offer ATM cards with liquid funds (Reliance Mutual Fund). This card allows you to redeem your money through any banks ATM. 4. Situations may change in future so it is advisable to review the amount after every 2 years.

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CAUTIONS: You will not drain the emergency fund for normal use. You should be clear when to resort to emergency fund. No NEEDS, WANTS or LUXURY will be bought from emergency fund. Needs are budgeted, wants and luxury are goal-planned. In case you have used emergency fund or a part of it- then you should again recreate or replenish it.

Disclaimer: The information contained in this report is obtained from reliable sources. In no circumstances should it be considered as an offer to sell/buy or, a solicitation of any offer to, buy or sell the securities or commodities mentioned in this report. No representation is made that the transactions undertaken based on the information contained in the report will be profitable, or that they will not result in losses. Rupaiyapaisa and/or its representatives will not be liable for the recipients investment decision based on this report.