Updated: Aug 24, 2022
To create a thorough financial plan, start with the most fundamental of requirements: emergency expenses. It is impossible to save for the future if your income does not exceed your costs. Although it may appear to be self-evident, this can be the most difficult aspect of the planning process. Even millionaires must periodically review their cash flow.
Working with a budget, cutting spending, and maybe raising your income are all ways to ensure good cash flow. It's difficult work, but it's so important that it's the foundation of the Financial Planning Pyramid, upon which everything else is built.
In order to have an accurate image of how much you can invest, a quarterly financial checkup (which you do, right?) should include an honest appraisal of what you spend each month. Even a small monthly payment of Rs. 500 might add up to a big sum.
The necessity of emergency fund:
When making plans for a financially secure future, everyone should prioritize having an emergency fund. The reasons why you ought to set up an emergency corpus include the following:
You tend to live a more peaceful, stress-free life when you have an emergency fund. This is because you are confident that you have a backup strategy in place in the event that something goes wrong or an emergency arises.
The extremely significant future objectives are connected to your savings. By covering your immediate expenses so that you don't have to draw from your long-term investments, an emergency fund enables you to realize your future goals.
It guarantees that you won't become caught in a debt cycle. If you have emergency cash on hand, you won't need to use credit cards or loans to get by during difficult financial circumstances. Thus, having emergency cash helps to prevent you from getting trapped in debt in a time of need.
Why do you need an emergency fund?
You'll want to protect what you've built once you've found a solid balance between paying bills and investing. An emergency fund is the first line of protection you should put in place. This should be in addition to your usual savings, which you put money into after you've met your essential necessities for the week or month. It's not a fund you use to pay your regular bills; rather, it's a fund you can turn to in times of need or for unforeseen events. Therefore, you must precisely build it to address any unforeseen financial needs that may arise for you.
Examples of different scenarios when emergency fund helps:
Suppose you run a business and due to the weak economy the business is not doing great, running your day to day operations is difficult. An emergency fund covers your expenses and operations.
Being a salaried person, you save a little every month, you invest that into crypto and equity to enjoy short gains, but turns out after a few months, there is a market turmoil due to war tension. You need funds for your son’s education but your funds are stuck in equity. An emergency fund invested in a liquid fund would have helped you here.
You are the sole earner of the family. One day while travelling to work, you meet you in an accident, the doctor has advised full bed rest for next 2-3 months until the wound is healed. The company being generous gives an advance salary for 1 month. After a month, you would need an emergency corpus to survive the remaining period.
You have a sudden pain in your stomach, you check up with the doctor to find out you have Appendicitis, you are upset but relieved because you have medical insurance to back up, But guess what, there are certain expenses which are not covered in your insurance, you got to pay yourselves. An emergency fund can act as medical corpus when needed.
How much is sufficient?
General thumb rule is to save three to six months' worth of costs, but you know, thumb rules are generic and consider average scenarios. Case to case factors differ like number of dependents, their earning, other sources of income, liabilities etc. . If you're self-employed or have a variable income, you might wish to save for a longer period of time. Sometimes, it can be a difficult job while setting priorities between Emergency Fund and other important goals like education, that's where a financial planner’s expertise, experience and unconventional ways can be useful to tackle the situation.
How to build it?
Investing in the right asset to have appropriate funds at the time of need is something we need to understand, just by the lure of short term profit, we are tempted and end up investing in highly risky assets, we do not follow the risk associated with it. Emergency funds should be characterized based on the liquidity and safety. Emergency funds should be built through Arbitrage Funds, Liquid Funds, Fixed Deposit, Savings Account each asset having its own risk-return profile, different taxation and exit load rules, which are considered while building Emergency corpus for our clients.
Family as an emergency fund?
For a joint family, members and relatives of a family also act as an emergency fund where they can back you and lend you money at difficult times. For someone just starting their career, the emergency fund can be taken by their parents and one can focus on life goals.
The need for safety and liquidity-
Supposedly looking around and excited by talks of crypto and equity investing, you get all hyped to start your financial journey. You start investing from the little you save from your salary and monthly expenses, everything seems good and a few months pass by. All relaxed about your investments, you hear news buzzing around about the market turmoil due to war tension between countries to become a superpower.
Even before you can digest this fact, you hear your phone ringing. It's your Senior Manager, he has called you in his office to disclose the fact that the company is laying off some of the workforce due to a financial crunch and you are one of them. You are terrified and completely blown away, you bid farewell to your colleagues.
The next day, you open your laptop to withdraw some funds to manage your daily expenses. The greens have turned into dark red, for your portfolio’s entire profit is gone. The invested capital is not safe. Now, you have only two options, you sell your holdings at loss or wait for the market to recover and instead take a loan from the bank or a relative.
You began to think where it all went wrong, you did invest and you also poured your all savings, still the day has come where you are in the position to borrow or sell your assets cheaper.
Your emergency fund's main goal is to provide immediate assistance when you most need it. While you may have a few hours or days to plan for some crises, you might need money right away for others. As a result, you need to have rapid and easy access to your emergency fund, either in the form of cash or in a savings account. A portion of the assets may also be used to purchase liquid mutual funds with low risk investments that simply hold money market securities. FDs or RDs may also be taken into account.
SO, ARE YOU EMERGENCY READY?