“Why do I need an emergency fund?”, queried Nitin incredulously as he sat opposite to me. “I need money for more important events in my life!”.
Nitin’s financial planning was in tatters. He was staring at huge challenges in his life – no planning; loans piling up thick and fast and no money left for investments. Nitin never realized the importance of having an emergency fund for a rainy day.
We go through such events every time in our lives. I always keep telling my clients – it is not the load that matters, it is how you carry it that matters. Challenges will come and go but you need to tackle them intelligently – in the personal finance space, meeting emergencies is a cakewalk, if you do it the right way.
The importance of having an emergency fund cannot be underestimated as Nitin’s case will exhibit.
Your emergency fund planning is important
Nitin and his wife work in software companies. They draw a decent salary each month. Their current investments are only in Gold ETFs. They were drawn to the yellow metal as the whole world is – little did they realize that systematic investment planning in equity diversified mutual funds could fetch them more.
So while everything seemed hunky dory for this family, around 3 months back, Nitin’s father in law suffered a heart attack and went under the knife. They needed an immediate 2 lakhs which Nitin did not have. He did not want to liquidate his Gold ETFs and there were no other liquid investments he had accumulated.
Advance salary from his current employer was ruled out as that was already used and Nitin was paying back the loan he had taken from his employer. With no money saved for a rainy day, Nitin ended up borrowing this money from a friend for 2 months.
It is at this juncture that he realized that he needed a financial planner and walked into our office.
I explained to Nitin that we needed to park some funds in an avenue that should be used for such emergencies. Had he done that, he would not have borrowed from his friend. While borrowing took care of the money he needed during the emergency, it’s a shame that a working couple cannot cough up that money when it is needed the most.
Now he has to repay his friend in two months – where will that money come from ? Nitin is looking at a one year plan to pay his friend back this money. That means that he has less money at his disposal to save for his future financial goals. His inability to save for emergencies has caused a collateral damage to his long term goals !
What use is getting home money each month to be blown over fine dining, a big LCD or your favorite shopping sprees at the mall when you cannot have money at your disposal to meet medical emergencies ?
The need of an emergency fund cannot be under estimated – it’s the first thing you do when you begin to earn in your career.
Saving for your future via goal based investing should then be on your radar.
Emergencies are of different flavors – you might lose your job in a recession; a sudden medical ailment might demand a huge outflow of money; costly consumer durables in your house might break down and need replacement; your 2-4 wheeler might become salvaged – in each of these instances, you need money quickly and only an emergency fund can help bridge the deficit.
You can keep aside 4-6 months of living expenses, EMIs and mandatory insurance premiums as part of your emergency fund. Needless to say, when the emergency fund is used up, it needs to be replenished back for future use.
Where to save for emergency fund?
It’s a no brainer that your emergency fund needs to be parked at places where you can get to easily and quickly – so it as to be very liquid. Don’t over do by trying to park the money in a product that fetches you more returns at the cost of liquidity. That would be a disaster.
You can either make this simple or very complex – you would have read that you can park this money in liquid mutual funds. While that is good, just that when the need arises, someone in the family should be in a position to login into the DEMAT account and sell the mutual fund to meet the emergency. How many of our spouses and parents can do that?
Think about avenues that can easily be reachable by more family members – the ones that come to my mind are Fixed Deposits (FDs) and sweep in savings accounts. So it might make sense to spread your money across these investment avenues so that using it when the need arises is easy.
So, all said and read, readers, do you realize the importance now; do you have one and if yes, where have you parked it ?