“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
The importance of having an emergency fund cannot be underestimated
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 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 or importance of having an emergency fund cannot be underestimated – 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, but someone in the family should be in a position to login into the DEMAT account. He /she should be able to 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 of having an emergency fund now; do you have one and if yes, where have you parked it ?
@Radhey,
Thanks for sharing real-life experience. Most people do not save for a rainy day. I think everyone should have an emergency fund. I have set aside one years expenses in emergency funds.
Keep educating your readers.
Rakesh
@Rakesh, Where did you park it Rakesh ?
@Radhey,
I have parked them in Savings, FD & MIPs.
Rakesh
Very true. An emergency fund is a must for any person and I believe this is the first step any one need to take before starting the journey to long term wealth creation. If you don’t have an emergency fund in place which is kept in a safe and highly liquid avenues you might be forced to sell your Equity Mutual funds or Stocks since they are of a highly liquid nature and might incur some losses and more importanly it will have an affect on your long term wealth creation since it will offset the affect of Compound Interest miracle on your investmet. I have kept aside 6 months expense as an emergency fund of which I have kept 25K in my savings account and the remaining amount is in my sweeping savings account.
@Shanil, Great stuff Shanil, thanking for sharing your valuable comments.
Thanks for the nice explanation.
Keeping an Emergency fund aside is really required.. I am into process of building one & keeping it in my savings account.. However I am really not clear about what exactly are “Sweep In” savings accounts?? How is it better than normal savings account??
Awaiting the comments..
@Aparna Nema,
@Aparna,
A sweeping savings work like a savings+FD account where in after a specified threshold limit the amount exceeding the threshold limit will be automatically converted to a FD and thus helping you earn higher return on your savings automatically.
You can check out the below link for more information.
http://www.jagoinvestor.com/2011/03/auto-sweep-bank-account.html#
@Shanil,
Thanks Shanil..
@Aparna Nema, I will do a post on this for you soon.
@Radhey Sharma,
Waiting for it…. Thanks..
@Radhey Sharma
I would be really happy if you also write an article for the beginners like me on “How to start Investing in Mutual Funds”..
AS we beginners use to read a lot on advantages of SIP in Mutual funds, long term planning, goal based investing etc.. But practically don’t even know how to start.. How to open a DMAT a/c, where to contact for it, how to buy mutual funds, how to monitor/ track the investments, what is the right time to sell, how to sell etc, etc, etc…
Just like u said “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?”
So Radhey, how could u help in this.. Ready to think for the next article?? 🙂
@Aparna Nema, All right madam, I will be on the case for you !
@Aparna,
In case of sweep-in account, you earn more interest, similar to that of FD. For eg. if you have 50k in your savings account. You can opt for sweep-in scheme wherein 25k will earn the normal savings bank interest and the other 25k will earn interest as per FD rate applicable. Speak to you bank for more information.
In case of hdfc bank you have to open a new account to opt for sweep-in feature, they do not have that facility in existing account.
Rakesh
@Rakesh, And ICICI Bank does not offer it at all. Kotak Bank does.
@Radhey,
hmmm, interesting, ICICI have stopped it. I remember some 8-10 years ago when my savings account used to exceed Rs.25,000 it was automatically transferred to FD A/c.
Rakesh
@Rakesh, Yeah, they were the pioneers in late 1990s and literally forced everyone to have it but I am not sure why they stopped it.
There must be a good reason they must have had.
@Radhey,
It was a good feature, you could earn additional interest without opening a FD. As for HDFC bank i already have two accounts, when i approached them they told me you need to open a new account for sweep-in facility. Its difficult to manage so many accounts.
I think you should write a post on How many accounts should one have?
Rakesh
@Rakesh, I did one long back. It is here –
https://www.thewealthwisher.com/2010/08/07/how-many-savings-or-bank-accounts-should-you-have/
@Radhey Sharma,
I have account in ICICI Bank and I am enjoying this facility.The fixed deposits in this case are linked to your savings account and are called Quantum Optima Deposits and are broken whenever you withdraw more than your savings account balance in certain fixed packets.Even public sector banks offer this facility.
@Anilji,
Does ICICI bank have this facility, i thought they removed it. How does it work, you call them and ask them to link it to your savings bank. How much is the rate of interest.
@Rakesh,
When you book your fixed deposits you have to tell them that you want Quantum Optima Deposits.You will get the interest of the normal fixed deposit of the duration applicable.Only this deposit is linked to your savings account and gets broken whenever you withdraw money from your savings account.The amount remaining balance continues to give you fixed deposit interest.
Anilji,
Quantum Optima Deposits? I had booked an online FD with ICICI for 1 year for 9.25%, did not find this option there. Will have to check with their customer service.
@Rakesh,
My experience with customer service is not good.You can approach them if you have any complaints but the problem ultimately gets resolved only at the branch level.I think you will have to approach the branch and insist that you want this facility.Many officers will probably initially say that this facility does not exist.But once you tell them that you know the rules, you will get it.
@ANIL KUMAR KAPILA, I agree with Anil, this could possibly be the case.
@ANIL KUMAR KAPILA, I thought Quantum Optima Deposits were withdrawn, looks like that is not the case.
@Anilji,
Thanks for your sharing your experience, i have hardly visited the branch for years, get the work done online or through phone. But as you suggested that we need to visit the branch directly and speak to them about this option, will do it once my current FD completes.
@Rakesh,
Thanks Rakesh.. How about SBI, IndusInd & IDBI? DO they allow to activate sweep in facility in existing accounts?? Eg, will SBI convert a normal savings a/c to a Sweep-In account??
@Aparna,
I have no idea about these banks, only knew about HDFC & ICICI bank.
You may have to contact their customer service and get more information.
Rakesh
@Aparna Nema, I know that SBI offers this type in their specific type of account. I also am not aware of IndusInd and IDBI. Its best to contact the branch/customer care.
@Aparna Nema,
I have this facility in my State Bank Of Patiala account.I think it should also be there in SBI.
Hey good one. Very well explained the significance of emergency fund.
Indeed its crucial to save a considerable amount for the critical times.
I had saved around 4-6 months expenses in bank’s saving a/c. But due to petty expenses & mainly to save income tax my emergency fund has reduced to a great extent.
So along with investment planning my priority would be to build up the emergency fund asap.
@Sudip D, Errrrr, pety expenses eating up your emergency corpus is not good. How will you ensure this does not happen in the future ? Keep 75% of it in FD ?
@Radhey Sharma, I know, but that’s one disadvantage of having considerable cash handy. Don’t know how to avoid this situation. Is FD a good option for parking the spare amount of emergency fund?
From the above Q&A I think sweep-in saving account is a good option. Got to enquire about it in my bank.
What do you suggest (to save the cash for actual emergencies & not spend it in petty expenses)?
@Sudip D,
Sudip, Why don’t you first find out how much you neet to set aside for emergency fund? It varies according to an individual profile. If you have a stable job and a regular income then 3-6 months of expense would be a good starting point.I would suggest that you can keep 10-15% of the emergency fund in your regular savings account and the rest in a Sweep in Savings account or in a Liquid Mutual fund.
Another thing is that you should never take money out of your emergency fund for tax saving purpose. Tax saving investment should be part of your over all financial planning since they should be looked at as a long term wealth creation investment rather than a mere tax saving investment. This is the reason why many people rush to invest in Tax saving products during Jan- March and invest in inefficient products and incur losses. ULIPs is a best example for this. People approach ULIP as a tax saving investments without realizing the high upfront costs and lock in periods of this product. ULIP can turn out to be a great long term wealth creation product if you choose them carefully and if you perform periodic portfolio rebalancing.But any day I would go for a Term insurance + ELSS + EPF as my prefered choice for Tax saving and long term wealth creation.
@Shanil, Man where were you – why don’t you do a guest post for me ? You have good writing skills !
@Shanil,
Agree with Radhey here, even though you have written very few posts but they are very well explained and in detail. You must be from financial industry or have done a lot of reading.
Rakesh
@Rakesh, A lot of reading. This is my side job. I love it.
@Rakesh, Thanks Rakesh. I am not from Financial Industry but I read a lot on Personal Financials nowadays. All you guys out there are doing an excellent job of educating the common man.I have learned so much from you guys and I am only trying to contribute back to the community with what ever knowledge I have gained and also based on my real time experience in trying to follow the knowledge that I have aquired.
@Radhey Sharma, Thanks for the appreciative comments.
@Shanil, Hi Shani..
Thank you for taking out time to write an elaborated reply.
You seem to be a new contributor to Radhey’s articles. I’m sure with Radhey’s informative articles & yours detailed reply to queries all of us would get VERY well acquainted with every aspect of financial planning.
Regarding my concern, yes I’ll find out my requirement for emergency fund & then distribute it proportionately in regular savings account & sweep-in savings account.
And regarding last moment tax planning, this is my first time as a tax payee so little misestimation this time. But don’t worry, I have learnt enough about ULIP so not investing in this anymore. For 80C my planning is insurance premium (existing ULIP but from next financial year it would be Term insurance) + PPF (started in Jan’12) + NSC (yet to invest in them). Also, need to buy a health insurance (which will come under 80D). And already paying for education loan (which comes under 80E).
So my emergency fund is exhausted in the above mentioned avenues.
But from next financial year I would definitely make it a point to create a considerable emergency fund, to plan for tax since the beginning & start systematic investing for the financial goals.
@Sudip D, Looks like you have everything under control my friend. All the best.
@Radhey Sharma, 🙂 Thank you.
@Sudip D, Why would yo spend emergency money for petty expenses at all ?
I suggest you park 50% in FD and 50% in sweep in accounts. That way you know you cannot touch the 50% in FD at all.
See how it works for you. Increase or decrease the % depending on how it suits you.
@Radhey Sharma, Thanks Radhey.
I’ll definitely plan to build (& save) the emergency fund properly in the next financial year. And also plan & invest systematically for tax saving & other goals. 🙂
Everyone has suggested to have a sweep-in account but missed one important point. What if that emergency fund is needed for you and you are unable to withdraw it due to any reason?
To be on safer side it is advisable to open a “joint” sweep-in account so that your trusted partner can also withdraw funds in case of emergency.
@Vivek K, Good point Vivek -thanks for bringing it to our attention.
Wow, happy to see these many healthy comments here. The first and most important point of finanical planning – Emergency Fund is well educated by article, well analyzed and explained by comments here.
Don’t think, I have anything more to add to this.
I am really feeling excited to read more comments here.
@Aparna: If you take little time and go to old articles of Radhey, am sure it will make you ready for the kick start, by the time Radhey come up with article for you.