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Indians are great at planning for the long-term like retirement, education of children, marriage and old-age healthcare expenses, but what happens when there is a crisis like a sudden job loss or the onset of a pandemic? Regardless of the circumstances, only 25% of Indians have emergency funds for a rainy day, according to a survey titled "India's Money Habits" by personal finance platform Finology.
The survey revealed 75% of Indians do not have emergency funds and could default on their equated monthly instalments (EMIs) in the event of a sudden layoff. " Indians consider their parents 'friends as an emergency fund. One out of three neither has health cover, nor an emergency fund, said the survey. Another striking data point which further necessitates an emergency fund is this: At least 29 per cent of Indians said their salary does not last beyond 15 days!
What is an emergency fund?
An emergency fund is the essential corpus of money that you should keep aside to tackle the unexpected financial curve balls that life throws at you.
"The primary objective of maintaining an emergency fund is to create a financial corpus for dealing with unforeseen expenses or for covering unavoidable expenses during periods of income loss caused by job loss, illnesses or disability. Without an adequate emergency fund in place, one would be forced to liquidate his investments earmarked for crucial financial goals or avail loans at much higher interest rates to deal with such financial exigencies," said Naveen Kukreja, Co-Founder & CEO, Paisabazaar.
How big should an emergency fund be?
"The primary objective of maintaining an emergency fund is to create a financial corpus for dealing with unforeseen expenses or for covering unavoidable expenses during periods of income loss caused by job loss, illnesses or disability. Without an adequate emergency fund in place, one would be forced to liquidate his investments earmarked for crucial financial goals or avail loans at much higher interest rates to deal with such financial exigencies," said Naveen Kukreja, Co-Founder & CEO, Paisabazaar.
How big should an emergency fund be?
An emergency fund should be big enough to cover the unavoidable expenses like existing EMIs, daily household expenses, children’s tuition fee, utility bills, expenses on medicines, insurance premiums, etc. for at least 6 months. For those having lower income or job certainty, this fund should be able to cover these expenses for at least 12 months.
Most thumb rules related to emergency fund planning state that you must have six--nine months of your fixed monthly expenses saved away in an easily accessible and low-risk asset class. However, your unique situation may require a sum that is even higher than this. "For instance – one who has just launched a venture of their own may need to have 2-3 times this amount saved up in an emergency fund, compared to someone with a stable income and a high reserve-surplus ratio, for whom even 3 months’ worth may suffice," explained Aniruddha Bose, Chief Business Officer, FinEdge.
For example, a double-income family with Rs 50,000 monthly expenses should have emergency funds for six months of expenses (Rs 3 lakh). A single-income family with the same monthly expense needs 10-12 months of expenses (Rs 5-6 lakh) as an emergency fund, said Ajinkya Kulkarni, Co-Founder and CEO, Wint Wealth.
You may also adjust the quantum of your contingency fund based on your changing financial obligations. " If you have taken a loan, increase your contingency fund accordingly to cover loan repayments. Once you have repaid the loan, decrease the size of the fund. Avoid parking your contingency fund in instruments which don’t offer easy liquidity or have a lock-in requirement," said Adhil Shetty, CEO of BankBazaar.
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How to get started:
CA Jay Desai lists down some steps to get started:
CA Jay Desai lists down some steps to get started:
Set a Target: Determine how much you need in your emergency fund. This amount can cover unforeseen situations like a medical emergency, sudden loss of income, urgent home repairs, and so forth.
Start Small: If three to six months' worth of expenses sounds daunting, don't worry. Start small. It could be as low as Rs 1,000 or Rs 5,000 a month. The goal is to start saving regularly.
Budget for It: Include your emergency fund as a line item in your monthly budget, just like rent or groceries. It's a non-negotiable expense for your future self.
Automate It: To make the process easier, automate your savings. Set up a recurring transfer from your main account to your emergency fund on your payday.
Where to invest?
The primary goal is not to earn high returns, but to keep the funds easily accessible and safe from market risk. Some options include:
Savings Account: A regular savings account is a great place to keep your emergency fund. It provides instant access to your money. Opt for a high-interest savings account to earn a little on your savings.
Sweep in Fixed Deposits: Fixed Deposits (FD) are safe and offer higher interest than a savings account. However, your money is tied up for a fixed period, and you could face penalties for early withdrawal. "Some banks in India offer 'sweep-in' FDs, where the amount over a certain limit gets automatically converted into an FD, providing higher interest," said Desai.
Liquid Funds: Liquid mutual funds are another option. They offer higher returns than a savings account and are relatively low-risk. You can usually withdraw money within a day. These funds invest in high-quality short-term credit funds. Such funds are only permitted to invest in listed commercial paper, and a maximum of 25% of their total assets may be allocated to any one industry. They are not allowed to invest in assets with a high level of risk.
"Remember, the best strategy for an emergency fund is one that ensures the funds are readily available when you need them, rather than earning the highest possible returns. It's a safety net, not an investment vehicle," said Desai.
Keeping money aside doesn't mean just save in your bank account:
Since emergency fund can be needed anytime it should be parked in highly liquid funds. Keeping money aside for emergency need not necessarily mean it should be kept in a current/savings bank account. " It can be invested in funds from where you can withdraw it as soon as they are required. Examples of liquid funds are - ETF’s, Mutual funds, stocks, Gold etc," said CA Mahima Vachhrajani.
Avoid equity mutual funds
"One should avoid parking his emergency fund in equities or equity-oriented mutual funds as equities can be very volatile in the short-term. Else, a financial emergency occurring during bearish market conditions can force one to make redemptions at capital loss," said Kukreja.
Don't chase returns on the fund
Investors should not chase returns on this fund. Instead, treat it as a safety net, which allows you to look at other opportunities rationally. "Once the corpus is ready, you can park it in one or more FDs with large PSU or private sector banks. It is better to choose FDs with a sweep-in facility to meet emergencies with a partial withdrawal. Money market mutual funds also serve the purpose since they invest in highly liquid, high-quality short-term debt instruments," advised Kulkarni.
One should always avoid withdrawing from the emergency fund for non-emergency needs like the hot investment of the week or a once-in-a-lifetime vacation." Ajinkya Kulkarni, Co-Founder and CEO, Wint Wealth.
What should home loan borrowers do?
Both existing and prospective home loan borrowers can consider availing home loan overdraft facility to create their emergency fund. Many lenders offer this product under the brand names like Home Saver, Home Loan Advantage, Maxgain, Home Loan Interest Saver, etc.
"Under this facility, a savings or current account with overdraft facility is opened and linked to the home loan account. The borrower can park his emergency fund along with other short-term surpluses in the overdraft account and withdraw from it as per his requirements. The home loan interest cost for the borrower woul d be calculated after deducting the amount deposited in the savings/current account from the outstanding home loan amount. Thus, the overdraft account would allow home loan borrowers to derive the benefit of making prepayments while allowing them to make withdrawals from this account to deal with unforeseen financial exigencies," said Paisabazaar's Kukreja.
"Under this facility, a savings or current account with overdraft facility is opened and linked to the home loan account. The borrower can park his emergency fund along with other short-term surpluses in the overdraft account and withdraw from it as per his requirements. The home loan interest cost for the borrower woul d be calculated after deducting the amount deposited in the savings/current account from the outstanding home loan amount. Thus, the overdraft account would allow home loan borrowers to derive the benefit of making prepayments while allowing them to make withdrawals from this account to deal with unforeseen financial exigencies," said Paisabazaar's Kukreja.
When to use the emergency fund?
In the event of an emergency, treat your emergency fund as a last resort. "Use it only when you don’t have the means to cover day-to-day financial needs, such as purchasing groceries, paying the electricity bill, repaying debts, etc," said Shetty.
Don't forget the medical cover
Alongside having a solid emergency fund in place, it’s also important to have a high-quality medical cover for your family. More often than not, it’s medical emergencies that leave a huge dent in our goal-based savings, and a good health insurance plan can safeguard you from that.
Alongside having a solid emergency fund in place, it’s also important to have a high-quality medical cover for your family. More often than not, it’s medical emergencies that leave a huge dent in our goal-based savings, and a good health insurance plan can safeguard you from that.
