One of the key facets of robust financial planning is to account for an emergency fund which in other words is equivalent to keeping some provisions in case of any unexpected occurrence such as natural calamity, issues related to personal health, or that closed ones, household bills, etc to name a few. This type of situation warrants immediate payment of money to tide over the crisis and emerge victoriously. It is different from investing in various funds to creating a corpus of your own to meet your financial goals. It is generally prudent to keep a buffer of 3-6 months of expenses as your emergency fund. There is no hard and fast rule or algorithm to this. It may so happen that you have lesser liabilities and lead a minimalistic lifestyle which can be easily managed by keeping a lesser buffer. The other extreme is you have piled up a huge amount of debt and have no control over your monthly expenditure. In such cases, the emergency fund must consider your income and accordingly your lifestyle to park aside from a portion of your income for such funds. Both spouses may be working which may result in higher allocation to an emergency fund. At a later stage when you plan for kids or you take responsibility for your parents, the scenario changes and your allocation will have to change based on the same dynamics. It becomes doubly important to consult the best mutual fund distributors in case you park a lot of your assets in SIP’s. Online mutual fund investment along with proper tax planning becomes important when you consider your emergency fund as a vital aspect of your sustenance and a corresponding increase of that fund that can match your living standard and debt that you have accrued over the years. Let’s look at a few aspects of emergency funds that people fail to understand while doing the allocation for the same. Let’s call it 5 things an emergency fund is not.
It is not a futile instrument that results in a waste of effort without resulting in anything: An emergency fund is not treated with the same importance as that of your regular investment. Crises can strike anytime without any warning. People generally do not attribute any value to emergency funds as they believe that funds can be sourced from various avenues. But there is a cost associated with this. It does not come for free. If you are taking a personal loan, it comes with hefty interest rates. Borrowing from family and friends comes with a lot of obligations and if the money is not paid in time, it may result in unwarranted humiliation. This becomes stressful. It is better to tap into your allocation for the emergency fund which you have amassed over the month for exigencies. You can withdraw money from your PF or stocks. But what if the market is at an all-time low and you need the money immediately. You could be at a significant loss or you may be depleting the money kept for your future or the education of your children. The trick is to manage the emergency without taking any further debt or impacting your household wealth. Hence planning becomes extremely critical.
It is neither an illiquid mode of investment nor solely a money-making avenue: It must be borne in mind that an emergency fund should be a liquid instrument which may be a liquid fund, an overnight fund, an ultra-short-term bond fund, non ELSS fund, a bank fixed deposit. It may be a combination of various things, but the key is that it should be redeemable as and when we want to tide over unexpected scenarios. ELSS, EPF, or PPF will not fit the bill in such scenarios. Stocks should be avoided as you may become a victim of market volatility and this may eat into your capability of wealth creation.
It is not a predetermined amount: Even though it is prudent to allocate almost 3-6 months of your monthly expenditure in the emergency fund, it is not a size fit approach. The allocation depends on the debt you have taken, the kind of living standard you maintain, planning for a future child, parents, or whether both the members of your family are working and can contribute to the fund.
It should not be looked at as an instrument for planned expenditure: Life is extremely unpredictable and full of surprises. Unexpected bills, medical emergencies, natural calamities, tax bills, or unexpected layoffs can be stressful and take a toll on your mental health. Financial security is needed. Even if you are withdrawing money from the emergency fund, ensure that you replenish the same amount as soon as possible. An emergency fund gives you the peace of mind and luxury of time at your hand. The true value can only be appreciated in times of need.
It is not an instrument for providing returns: It makes no sense to keep your money idle in your house or the bank. It will remain stagnant with no value creation. We should not forget that our needs increase over time. The kind of living standard that we enjoy may not be the same as in coming years. Inflation is on the rise. Prices are on the rise and macroeconomic uncertainties are part and parcel of today’s changing world.
It becomes imperative that we consult sound financial distributors, online mutual fund investment, and tax planning tools to make our emergency funds work. A combination of liquid funds with a decent return will help us in compounding our corpus although the sole motive is not to create money but to ensure that it grows at a rate more than our future expenditures. Proper allocation to your emergency fund will give you the luxury of time at the same time peace of mind. It provided you hedge against volatility, uncertainty, and vagaries of the market and life. If it is planned diligently and systematically, it has the power to change your life for the better.
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