Let me clarify – What is Emergency Fund?
An emergency fund is a corpus that will be used to meet expenses related to unforeseen events of life. The aim to have emergency money is to avoid financial hassles which may deviate you from your savings for your long-term goals. A typical example is that this money will not be utilized to replace your 5-year car (as the replacement of the vehicle will be covered in your financial plan) but an emergency fund can be used to make a down payment in case your car gets stolen and you need a replacement immediately.
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Why is an emergency fund important?
When you hear the word emergency all of sudden the ambulance alarm seems to go ON at the back of your ears. For us, emergency means just one thing- a road accident. And on second thought, a lot of us think why to keep an emergency fund, when we travel in a car. Traveling in the car has a low probability of an accident so I don’t need an emergency fund. Hospital charges will be met by mediclaim or by my rich papa so why to have an emergency fund?
When The Emergency Fund is to be utilized?
1) Medical emergencies if do not have cashless provision with the mediclaim provider.
2) Financial emergencies like replacement of assets in case of sudden breakdown.
3) Income emergencies like loss of job or slowdown in the profession for cyclic reasons.
4) Household emergencies like expenses required for the education trip of a child or a house repair which needs immediate attention.
5) Your friend or family requires support due to a medical emergency. (not for buying a new flat)
6) Availing offers which can save money in the future like making payments to reduce the principal amount in case of interest rates rise in flexible interest home loans.
These funds can be used to help to stabilize your monthly budget and even making a few savings like saving on late payment penalties and allows you to negotiate price in certain cases as you have the money to purchase in bulk.
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How Much Emergency fund is required?
This is a serious question and requires a bit of calculation. Different experts have suggested different ways ranging from 3 months expense to one year expense. The monthly expenses are very easy to calculate if you do budgeting. But this kitty of the emergency fund is a dormant investment as the rate will be low as liquidity will be preferred. So if you go much beyond what is needed you are losing some profit you ought to earn. Hence deciding on the amount has to be accurate. I recommend that in the modern world one thumb rule will not suffice for clients with different backgrounds and earnings. Hence I would advise that you should maintain the emergency fund as per the following situations:
- In case you have a volatile job or business with no other source of income at least aim to maintain 12 months monthly expenses in your emergency account.
- In case you have a stable job but have a mortgage or an EMI running, which is over 40% of your salary, you should aim at keeping 9-12 months of monthly expenses and at least 6 months of EMIs in your expenses.
- In case you have a fairly stable job or industry and a working spouse you should aim to keep around 6 months of monthly expenses in your emergency fund.
- In case you have a stable job and a working spouse with no or very minuscule loans, you may keep at least 3 months of monthly expenses in your emergencies expense fund.
- You must also take into factors your personal situation. If you have a large family to support or someone in the family who is disease prone you need to increase the emergency fund accordingly.
For Better Understand What is Emergency fund Watch This Video –
How to create an Emergency Fund?
To set it straight, your credit card in NOT your emergency fund, so do not boost that you have a credit limit of lakhs and hence emergency fund is not required. The cash or credit drawn on your card is a loan and a very costly loan. Also you the extent of time the emergency will take to settle is also uncertain. So you may end up yourself with banks chasing you for their money. You need to create a kitty of your own.
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The steps to create an emergency fund are:
- Fix the amount that you wish to save to allocate to an emergency fund. As discussed this will be decided on the individual situation a person is into. So instead of asking a friend how much he has in his bank (he might also think that you are asking for a loan), it is better to put your own mind into calculations.
- Know your monthly expense as its helps both ways. You know how much you can save on a monthly basis and also you can calculate what emergency expenses you require.
- Open a separate savings account with the bank and designate this account as an emergency fund. Bank does not recognize any account on the basis of emergencies. For them, this is an individual account and for you, it should be a non-personal account only to be used in case of emergencies. See that you have the ATM card facility with the account.
- Redirect your savings: now start redirecting your savings to this account. You may set an automatic transfer or do it on manually but you must maintain discipline in maintaining your contribution till the desired corpus is created.
- When the corpus has been created ask the bank to add the auto sweep facility. You may also take the help of your financial planner to help you invest in money market mutual funds.
- Situations will change in the future so it is advisable to review the amount after every 2 years approximately.
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Where to keep the Emergency Fund?
The emergency fund has to be in liquid and easily accessible. You may keep at least 10%-15% as cash at home in properly secured almirahs or vaults. Do not keep much as this will invite burglary. The rest can be put in Banks savings account with an FD sweep facility and ATM cards. Around 40-50% can also be invested in money market mutual funds. But in case you invest in mutual funds you should be aware of the process to withdraw.
You will not drain the emergency fund for normal use. You should be clear when to resort to an emergency fund. No NEEDS, WANTS or LUXURY will be bought funded from the emergency fund. Needs are budgeted, wants and luxury is goal-planned. Also if you have used an emergency fund or a part of it you should again recreate or replenish it.
What has been your experience with the emergency funds? Do you have it? Or do you plan to create it? Or do you think otherwise? Share your thoughts in the comments section.
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In this uncertain and changing environment, for sure, a careful family should have emergency fund or corpus all the time. Though presently, I do not have but have started baby steps and am on the way to have proper emergency fund in coming months and again thanks to Hemant for timely advise.
Starting Small is a good strategy as taking first step is toughest job of any work.
I started a Income Fund in SIP mode and intend to keep this amount as Emergency Fund. My SIP will run for 5 years and by that time it should be covering about 6 months expenses.
My suggestion will be that you should think of building this anyhow in 1-2 years – check the various strategies mentioned above.
Thanks Hemant for your suggestion.
Currently I am having a two tier approach. Some amount (~ 2 months expenses) is kept in Sweep-In FD account and to build the rest I started the SIP this year. The problem I see in keeping the full emergency fund in FD’s is that the interest will be taxed if it crosses 10,000/- per year limit.
I will try to increase the SIP amount once the loan gets cleared.
Two tier approach is perfect but this 10000 interest benefit is only applicable on sb interest not fds.
I maintain emergency fund of around six months expenses in a savings account linked to fixed deposit with sweep in sweep out facility.
So far I have used this fund for replacing lap top of my daughter which got burnt due to over voltage.
I had to also replace the damaged batteries of my inverter as well as damaged geysers and refrigerator using this fund recently.
Hope after using that fund – you replenished that.
Yes I replenish the fund after using it. I have observed that every year I have to incur some unplanned expenditure on maintenance such as plumbing and electrical fittings, wood work and masonary etc. I think it will be a good idea to make provision for maintenance in household budget itself.
Good one and interesting
We have started saving for our emergency fund (6 months of our home budget) in FD. I had not thought of auto sweep facility. This was an eye opener. I will find out from the bank if any such facility is available.
I think SBI provides the best auto sweep facility among other banks. I m maintaining my emergency fund in it.
Why you feel sbi is best in this case.
SBI calls this facility MOD facility which is very good. Other banks offer flexideposits or Sweep in sweep out or over draft facility.
Thanks Hemant for another”perfect”article…covers all practical points and it is very much feasible to implement..
Thanks again for this article..
Like very much the idea of separate bank account for emergency fund with ATM..
Thanks Amit… But take action 🙂
This is indeed a very thoughtful and important article to go through. Thanks for reminding me of yet another important aspect of savings. TFL rocks!!!!
Very useful, thanks for sharing such a great post…
Thanks Ajeeth… Must share with your friends.
A wonderful article, we have started building our emergncy fund based on the fact that we need atleast 6 mnths of expenses….
I simply follow a logic, transfer the maximum in 5-6 months span of time (i use my wife’s salary completely to be transfered to emergency fund), this way emergency fund is created fast and you be at ease. I did it last year from May till Novemeber and i also made sure it went into autosweet earning me 8-8.5% interest on it. I kept a small amount (10%) at my home for urgency and often take out small amounts and replenish it back as soonas i have money in hand…..
Mind you guys, this gives a lot of mental peace thinking that you have a fund to take care in case something unwanted happens.
Thanks Hemant for the wonderful article, you guys work round the clock to enlighten us.
Thanks for sharing you strategy and how you feel after creating emergency fund “Mind you guys, this gives a lot of mental peace thinking that you have a fund to take care in case something unwanted happens” 🙂
Sweep in Sweep out facility means ?
A sweep account is an account set up at a bank where the funds are automatically managed between savings account and fixed deposits.
Very nice article covering important topic.
We (me and my wife) have been creating emergency fund for the last 1 year and kept the target of 2.5 years in order to have emergency fund for 4 months (which includes home loan EMI and monthly expenses).
When we decide to have emergency fund, we feel very important to decide on “what is emergency for US” and this helped us a lot to keep this fund intact.
As you mentioned, we have separate a/c for the same. I follow the strategy of keeping one month’s fund in saving a/c and remaining in FDs. We choose the option of FD as one can get the money at max in 1-2 days.
One more thing we followed is we try to avoid any transaction in this a/c unless it is required for any DEFINED emergency. We carry ATM card of this a/c only when we are out of station.
You righty said its important that this amount should not mingle with other regular funds.
Dear Harsha, Auto sweep is smoething like an FD but with out any timeframe attached (i mean no lock in period), they provide nearly FD returns of around 7.5 – 9% (depending on bank to bank). You can anytime with draw the money at a swipe of your ATM Card…. the FD then breaks for that amount and rest is still continued.
Hope i am clear.
Wonderful article & very useful too . Thanks for sharing…
I am lucky to be a regular TFL visitor since more than 2 years now and I feel fortunate by reading your articles at that time itself as a result I was able to build an emergency fund. This is really the most fantastic article and if I am not wrong then perhaps the most important of all the articles in TFL for financial planning.
The point that I want to make here is I dont think any kind of mutual fund can be your emergency fund even though how secured that fund may be..Savings bank account from a recognized bank is the best option for emergency fund.
You are still conservative after reading my articles for two years 😉
Another eye opening article. thanks for this wonder ful article
I had kept emergency fund but without much calculations. After going through your articles on financial planning with the help of local CFP extra amount is invested in MF.
Thank you very much for educating.
A very well versed and informative Article.
One point I would like to say.The Reliance Mutual fund has option to Have ATM card facility for mutual fund investment.So u can withdraw maximum of 50% of your fund value from it.So investing in any good reliance Liquid fund will be good choice as one can withdraw money in case of emergency.this facility has no additional charges.
This is definitely a good option, invest in ril money managers fund and redeem through ATM.
Its really a nice article, now am planning to open a SB a/c for only emergency fund thanks a lot for such a nice article Hemanth Good work once again….
I have 8 lac rs as bank balance which is in form of FD & i donno what to do wit it. So its like a emergency fund for me as its in bank from past 3 years. 🙂
Try to assign some of this amount for long term goals.
Dear Hemant ji… Once again an EXCELLENT ARTICLE from you. It is soooo useful to all. Though I am maintaining Emergy Fund for the last 5 years, this article helped me to improve my fund position. Me along with my brothers are maintaining a common fund by monthly contribution for meeting emergency expenses for whole family including parents. Now, we have to revisit to our contributions and increase further. Tks / Mahesh, Baroda
Good to know that you are already having emergency fund and you also know its importance.
I, in the back of my mind, always have this uncanny feeling of not having any back-up financial plan or plan ‘B’ to meet the expenses of unforeseen events of life but never had a solid idea how to go about it. Even though I have some amount earmarked for it, it was never in a systematic way. Now, I am started thinking like a finance minister. Thanks for your article.
Good do know that now you feel like finance minister but don’t manage finances like our chindu 😉
Very useful and must read and follow for everyone.
Wonderful article specially people like us who works abroad and no job security, but one good thing is in Canada, goverment take care for 6 months with unemployment insurance which is almost 60% of your salary.
Hi Hemant, a very well laid-out article grounded in ‘reality’. Great! I suppose the use for an emergency fund is a long list, an unforeseen visit to native, family bereavement and consequent expenses or even an insurance premium payment that almost escaped your mind. The list can be endless. Hence, building a kitty for this can be useful in myriad ways. Tks, Vidya
Thanks Vidya for sharing your views 🙂
You were the person who put this idea almost a year and a half ago, after reading one of your article i started to do so, and you will be surprised how and when I used it, as I stay out of my state, I was informed that my mother was about to go for a heart treatment, she is 75 years old. The day she went to Fortis hospital Kolkata, my brother called me and told me that the doctor has advised to go for angioplast and the cost is 160 000. Thanks God I had it ready.
Thanks to you for your adviced which saved my mom that day.
Thanks Tony for whatever you have written. But credit goes to people who take action – so you deserve this credit much more than anyone else.
D/Hemant Ji, Thanks for sharing useful & excellent article.
Hi Hemanth..Thanks for such a great information. I am already maintain separate SB account for emergency fund in SBI but the ROI is very low( I think it is around 4%) when we compared to other banks. So shall I put this emergency fund in any liquid fund where I may get high return % and I can still withdrawn money as and when there emergency requirement. Please provide your views on my idea and suggest if any other alternate plans.
A general and useful way to manage it is have 60-70% in SBI Savings account with Auto Sweep option – This will give you 8-9 % retunrs.
20-30% into Liquid Funds
10% at your disposal always.
This works well… the 10% Cash athand will be very useful as in not to break ur FD or your Liquid Fund (and add the interest amount to your tax slab – Thus making it inefficient in context of Tax).
This is what i follow.
You can request for SBI Auto Sweep and keep the Funds there yeilding 8-9%.
Wonderful article specially people like us who don’t have any emergency fund.
A lot of thank.
Thanks for this great article, i have a problem as i have taken two LIC Saral policies with installment of 2000 and 3000 per month and now i am not able to save money….Please suggest what to do in this case and please give ur views abt this policy…
Thanks in Advance,
thanks for the grt article.
I am investing a fix amount through SIP in HDFC treasury fund (Liquied fund) and considering it as a emergency fund. i have enquired that it will take 24 hrs to withdraw the mony from liquied fund. should i continue with this or transfer it to in SB A/C in bank.
I used to invest in sip sbi global magnum during the year mar 2007 to feb 2008 . Thereat i was maintaining bk at BOB. During 2010 an yield was declared and i recd thru bank. After i closed the bk account. After during 2011 nect divident announcement made but I didn’t got the yield because I neithet haf the Account there nor intimated to the institution.
If I contacted CAMS they asked for evidence for the older bk. And asked to get nit receipt of that dividend from the old bank. The bk is not ready to give?? To get the divident what else do i give. Suggest ways to get it
Thanx sir. its very important write up.
Would like your valuable comments:
1) I’ve opened a joint bank account with my wife and I treat it as a emergency fund account;
2) I’ve started couple of FD’s & RD’s associated to this account;
Is this the right approach?
Thanks for the post. I have started SIP of 5000rs per month to create the emergency fund. Is it the correct approach,nothing in cash but mutual funds only.
I think it is best intiative we should take for meeting risk in life.
Very good article…
This is nice article you shared great information i have read it thanks for giving such a wonderful Blog for reader.
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