Emergency fund – the FIRST and most IMPORTANT step in MONEY PLANNING

Emergency fund – like pensions fund for retirement expenses this is the money you keep aside for emergency needs.

What is your Emergency fund for?

Sum kept for

1. unforeseen medical/ accidental expenses,

2. major repair of home/ appliances,

3. car fixes,

4. unexpected taxes…

5. or other such random unclassifiable expenses.

What if you lose your job? What if your family loses the sole bread winner due to some mishap? – where will you get your living expenses from?

For every use state above except living expenses you can get some sort of loan from bank. No one would lend you money for Living Expenses. It still takes a few months to get another job or insurance claim while you can’t stop living till that money comes and need expenses to take care of your family.

Living expenses – The first and most important use of Emergency fund, which is rarely talked with as much importance as it deserves.

Many of us are facing tough time due to it today during this COVID19 pandemic – With so many job losses, unemployment is at around 20%-25% in many parts of world, highest since the Great Depression. So many people working at reasonably good positions are saying it’s going to get tough for them to survive for more than a couple of months without job. They can’t pull out money from stock market as that would mean booking losses.

Now that you know what is the most important use of Emergency fund, you need to estimate the how much, how and where.

How much should be your Emergency Fund?

To calculate this, you need to know two things –

1. What expenses should the emergency fund cover?

2. How many months of expenses should you keep in emergency fund?

Expenses to be covered

How to calculate your essential living expenses and monthly liabilities – look at your monthly budget and select the following items and add to get total. If you don’t have a budget make one or find out the values for below mentioned expenses for your household.

Expense items to be added– monthly numbers only

Add the monthly numbers for above expenses for your family. The sum is the one-month emergency reserve you need.

There are certain expenses that you shouldn’t include while calculating emergency fund requirements –

How many months of expenses to keep in emergency fund?

Your emergency fund should cover your essential living expenses and liabilities for 6-8 months. This would give you enough time to get back on your feet either by getting alternate employment or getting insurance claim approved.

Amount to keep in Emergency fund –

How to accumulate for your Emergency fund and where to keep the funds-

Saving for the fund – before you save for anything else you have to gather your emergency fund. Even before you pre-pay your higher costs debts you should save regularly till you reach your required emergency fund level.

Where to keep the money – you need to keep the Emergency fund money separate from your regular savings bank balance and also separate from your other goal related savings. Emergency fund must not be touched for any other purpose than a real emergency. Also, it should be kept in place where liquidity is highest and risk is lowest. So that you know in case of need you will be able to access it quickly, easily and without any fear of losses.

Where not to use the Emergency fund

Only the expenses that are important and urgent i.e. must be met now should use Emergency fund. Never ever use Emergency fund for any other expense.

This whole article talks about Emergency fund as the most important part of a personal financial plan, rather its need goes beyond the financial plan, i.e. whether you have a financial plan or not, you are investing or not… you must have an Emergency fund and there is not better time to talk about this than now. Every morning when I get up and read the news where people with reasonably good career are confessing of having no money left to run their household due to lockdown, I can’t think about anything other than Emergency fund.

In summary every household must have an Emergency fund that can help them during tough and challenging unforeseen circumstances.

6 steps to building and maintaining an Emergency fund –

1. Understand the need for Emergency fund

2. Calculate the sum you should have in your fund

3. Save to build your Emergency fund before anything else

4. Keep the sum in a separate account

5. Use it for only essential, mandatory or accidental expenses

6. Replenish the sum used from Emergency fund on ASAP basis

In the next article we will talk about Household Budgeting – the most essential step that forms the basis of your DIY personal financial plan.

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