HOW TO DEAL WITH FINANCIAL EMERGENCY?

Please select, what do you think what will be the first thing that would come in a person’s mind if he/she hears that he/she doesn’t have his/her income source anymore?

A)      Oh My God! How am I going to bear my monthly expense, bills EMI & loans repayment?

B)      How can I develop an another source of income?

We pray that no one in the world should face such a situation, but life doesn’t go as per our wishes & everyone has to face their share of challenges & emergencies.

But from the above two option, I don’t want to be the person like in option A. As you can clearly feel that although the emergency in both the option is the same, but in option B the person is clearly having a better mental condition.

OK, just one more question,

Please select, what do you think a person should do at the time when a fire broke out in his house?

A)      He should use water to extinguish fire.

B)      He should dig a well to gather water which he will use to extinguish fire.

Obviously, any sane person would say option A

Now, you can clearly understand that I am pointing to the preparedness for the emergency situation. And in this article I going to cover the financial preparedness part i.e. emergency fund.

Before proceeding further let us have a look at the topics to be covered in this article:-

1. What is an emergency fund?
2. Why should I create an emergency fund? Importance of the emergency Fund? Benefits of the emergency Fund?
3. How to create an emergency fund?
4. How big should my emergency fund be?
5. What are the factors to be considered while deciding the size of an emergency fund?
6. Where to keep my emergency Funds?
7. What is considered an emergency? When you can use your emergency fund?
8. What isn’t an emergency? When you shouldn’t use your emergency fund?
9. Important Points about emergency funds to keep in mind.

1) What is an emergency fund?

In very simple words Emergency fund is the money kept aside with the sole purpose of handling financial emergencies which is easily & immediately available. Or we can say it is a highly liquid source of money which is to be used in case of emergency only. Emergency funds are the foundation of strong personal financial plans.

2) Why should I create an Emergency Fund? Importance of the emergency Fund? Benefits of emergency Fund?

• We have learned at least one thing in the past 12 years witnessing 2 major global financial crisis, First - Great Recession of 2008 & Second – COVID 19 Pandemic, that there are factors beyond our control which can drastically change your financial situation overnight. By building up an emergency fund, we can be prepared to tackle emergencies.
• In case of an emergency, we don’t have to turn to credit card debt, family loans, or other borrowing options that create unnecessary financial stress which can lead to a vicious debt cycle.
• Having an emergency fund gives you peace of mind to know that if something truly bad happens, such as losing your job, you can think about how to deal with the emergency itself and not worry about how you’re going to bear your monthly expense.
•  If you've built your emergency funds, then you would also have the capability to make big life decisions more easily. You can even plan to change your career or follow your dream or passion.

3) How to Create your emergency Fund?

Here you can use 2 methods

1. Monthly contributions
• Calculate the amount that you want in your emergency fund.
•  Set a monthly contribution target.
• Save money every month. Just click here to Learn the no. 1 method to save money every month.
2. Annual/Surprise contributions
Any Income other than monthly salary can be used to contribute to emergency funds for ex.
• Bonus
• Tax refunds
• Selling of unnecessary items.

4) How big should my emergency fund be?

Here I slightly agree & slightly disagree with the experts

most financial experts say:

• Size of emergency fund will vary from person to person,
• A fully stocked emergency fund should hold between three to six months of expenses.

The first point I totally agree that the size of an emergency fund is different for different persons. But for the second part, my experience tells a different story I believe that with the emergency fund one should be able to manage the expenses for a minimum of six months, only to have better peace of mind so that one can focus to tackle the emergency.

5) What are the factors to be considered while deciding the size of an emergency fund?

• Stability of career:– If you have an unstable career with low-risk tolerance. You'd probably want to have a large emergency fund. But if you have a stable career with a high-risk tolerance, then you might only need for a few months' worths of expenses on hand.
• Difficulty in replacing your existing income:–

o   Easy: I could quickly get another job with similar pay.

o   Average: I’m well qualified but it may take time to find a new one.

o   Difficult: Jobs in my field and salary-level are limited or competitive.

o   Very difficult: I lack the right skills for the job market or am in an industry in which it takes a long time to land a new position at comparable pay

• No. of income sources:– If a person has a single source of income he might require large emergency funds comparatively to a person having 2 or more sources of income.

6) Where to keep my emergency Funds?

Here I totally disagree with most of the Experts who recommend using liquid funds to keep your emergency fund. To understand the reason behind this disagreement let us first understand the basic requirements of emergency fund instrument:-

i)                    Money should be immediately available. (high liquidity)

ii)                   Capital should not be at any market risk.  (Low volatility)

Note:- we should select only those instrument which earns maximum interest while fulfilling the above 2 mandatory requirements.

Considering the above 2 mandatory requirements liquid fund is also an option but not the best option as the interest earned in it is more than saving accounts but less than FD. Actually they benchmark the saving bank interest & then say that liquid fund earns more interest so keep your emergency money in a liquid fund. Now why the experts say so? The reason is that in conventional FD doesn’t fulfill the first criteria completely.

But nowadays there are online Flexi Fixed Deposit options in many banks in India that allow you to online open a Flexi Deposit scheme & allow online premature withdrawal also. This flexibility of early withdrawal of Flexi Fixed Deposits allows you to liquidate the investment in the event of any emergency.

Hence the best place to keep your emergency funds are:-

a)      Cash at home    – 10 ~ 20-day expense.

b)      Saving Account – 1-month expense

c)       Flexi FD           – Rest of the amount.

7) What isn’t an emergency? When you shouldn’t use your emergency fund?

Sometimes we have some unexpected or big expenses so we are tempted to use the emergency fund & we try to convince ourselves with silly logic, so it is important to draw a line between emergencies and everything else for ex. emergency funds should not be used for:-

• Occasional, Predictable Expenses like changing of car tires, etc.
• One-time Costs like property tax, insurance policy renewal.
• Planned purchases like a house, a new car, etc.

8) What is considered an emergency? When you can use your emergency fund?

A situation can be considered an emergency & justify the use of the emergency fund only if It is:-

i)        Unexpected

ii)       Necessary

iii)     Urgent

Following are a few examples of emergencies where it would justify to use your emergency fund

• Job loss
• Unexpected medical expenses to maintain your health
• Sudden unexpected car breakdown or accident
• A sudden unexpected problem with a major system in an owned house such as an air conditioner, roof or electrical system
• A family member gets hurt and you need to take time off work to provide the necessary care.

9) Important Points about emergency funds to keep in mind.

• These funds are completely separate from the retirement savings and any investments in the stock market, mutual funds, etc.
• In the very starting it does not have to a large, unattainable amount. Build a small emergency fund first.
• Prefer the banks which allow partial withdrawal in Flexi FD.
• In case of partial withdrawal is not available, never make a single Flexi FD of the total amount decided. with a no. of small amount Flexi FD when you will need to withdraw only a limited amount of money rest of fund will continue to generate interest.