An Emergency can strike you without knocking your door. If you are in job, loss of it can be a big setback especially at higher profiles where getting a new one is difficult. Similarly a medical emergency can drag you few years behind if you haven’t made any provision. There can be other emergencies where you may need large chunk of money to deal with it. In all such circumstances the impact can be huge if you do not have funds to sail through. Many a times it even leads you to force borrowing thus making you fall into heavy debt. Then it takes years to come out from it.
Considering all situations above having an adequate emergency fund should be one of the top priorities in your financial well being. But still the confusion prevails how much of it is adequate and what should be included in building an emergency reserves for yourself.
Here is how you should go about building emergency reserves for your financial situation-
How much is Adequate?
Most of the time we jungle upon how much emergency fund we should maintain. Some of us perceive a two months expenses should be enough while some of us who are at higher age try to keep a much higher reserves for meeting emergencies. Each one of us have our own perspective based on our life stage and rightly so as it depends on what expenses you have and what liabilities you are running. The most important consideration is that during emergency situations you should be able to meet your expenses for few months till you settle it. How much months should be sufficient is an answer which is based on your requirement. Ideally minimum 4-6 months expenses is what you should maintain at any stage of your life. This is primarily due to the factor that even in a job loss it takes some time to get a new one. Although situation like these can be more prolong but any amount below this can force you in financial problems. Above this the emergency fund corpus is based on your specific requirement. For example in case of a special child parent or post retirement you might have to keep 8-9 months expenses in this account. Similarly there can be many other situations where you may need higher funds in your reserves to ride through difficult times. Your exact requirement can be identified once you analyze your financial situation.
Below is a effective calculator at moneycontrol which helps you in identifying your emergency reserves:
What It Should Include?
The main objective of having emergency fund is to meet all your expenses whenever there is a sudden discontinuation of your income. So in general the emergency fund should include all your expenses you require to maintain your living. This will include your household expenses, utility repayments, your loan EMIs repayment, children school expenses etc. These are expenses which if not met you or your family may suffer. Your insurance premium payments such as term, healths etc… which are important for your family protection should also be included. However, investments can be deferred for some time if emergency arises. Although discounting them may hit your accumulation but during emergencies your living expense are on priorities which has an impact today. Still if you have enough savings to accumulate for them then you can do it. Apart from this any other expense you need for maintaining your living cost should be part of your emergency fund.
When You Should Utilize It?
It is also a question that what should be termed as emergency. In our life we may treat many event as emergencies but may not be really so. Ideally any situation which hit your earnings capability or you have to shell out a large corpus that it stretches your finances should be treated as emergencies. So job losses, sudden hospitalization, death of family member are situations where you will be impacted financially. But if you need to repair some electronic items or need a replacement then these cannot be termed as emergencies and should not be funded from your emergency reserves.
Where You Should Not Keep It?
Emergency fund is for immediate utilization and so this corpus should be kept in instruments which are highly liquid with no probability of capital loss. You should not be worried much about earnings and so should not be lured to earn higher returns. Capital protection is the main objective while investing your emergency reserves. Ideally savings account, fixed deposit, liquid and ultra-short term funds are the most appropriate avenues for parking your emergency fund reserves. Once you have identified your emergency corpus you can choose avenues. In general a mix of these is the most ideal choice. Avoid investing in MIPs, Equity, and long term debt products where risk to capital is too high.
Emergency funds are meant for dealing with financial situations which impact your well-being. If you do not have enough funds while in emergency it has full potential to wipe out your savings. Borrowing from your families, friends or relatives will bring you at toes since you will have liabilities to repay them. These relationships are most tricky to handle and should be dealt with care. To avoid any dissatisfaction later it’s wiser that you identify your expenses and start building corpus for your emergency reserves.
What emergency funds you keep? Where you invest them?
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