Introduction:
- Hello, there are some questions that you have repeatedly asked us through the comments of our post. How to make an emergency fund? How much money is enough to create an emergency fund?
- Where to invest emergency fund? Today I will answer all the questions, and in last, with the help of a spreadsheet, I will also tell you how you can create your emergency fund. So must read the post till the end.
What is an emergency fund?
(1) Let's start with the basics. Simply put, an emergency fund is a 'just-in-case' fund that ensures that you don't run out of money in case of any unforeseen circumstances. For example, during Covid and even now you must have heard that companies are laying off their employees.
(2) So, in such situations, your household expenses continue, and you can manage them without taking a loan or breaking your investments, this is where an emergency fund comes in handy. Emergency Funds can be used in the following situations:
Why is emergency fund important?
(1) I know that maybe you must be thinking that when I am doing a good job, saving, then what is the need for a separate emergency fund? Let me accept your point that you save a good part of your income. But here you must keep your emergency fund separate from your savings. This distinction is important because if you do not set aside your emergency fund, you will end up using that money for non-emergency purposes. Having a separate emergency fund will give you a sense of financial security and the peace of mind to handle difficult situations with confidence. That's why having an emergency fund is a fundamental part of personal finance.
(2) See Life and health insurance helps you in the most unexpected situations, but as per the latest available data, the penetration of insurance in India is very low at just 4. 2%. And then insurance doesn't need to cover all your expenses. And even if tax is taken, in the case of health insurance, most people first pay from their pocket and then claim that amount. So in such a situation, you must have an emergency fund, which you can tap into whenever you want.
(3) Well, we recently made a video on "Common Insurance Traps" on our "Groww Insurance Academy" channel, so if you want to know what you should be aware of while buying insurance, you must check this video. And can also subscribe to the channel "Groww Insurance Academy". Now we have understood what is an emergency fund, and why it is necessary. Next, I will tell you how big your emergency fund should be. Here's a thumb rule for how much money you need for an emergency fund from a finance expert.
(4) As a rule of thumb, the emergency fund should be large enough to cover at least 6 months of your work expenses. But I would suggest that you prepare for the worst, and create an emergency fund equal to 12 months of your expenses. Now you do not have to count the expenses of vacations, outings, and going to expensive restaurants in these expenses. Or else, your emergency fund will become huge without any reason, and you think to yourself, will you spend unnecessarily during an emergency? No isn't it? I am saying 6 to 12 months of expenses as it is difficult to predict exactly how much time it will take to crack a new job in case of unemployment,
(5) but in such a situation, you or your family Should not have any problems financially. For example, if on average you spend ₹20,000 all the time, you should always maintain an emergency fund of at least ₹1. 2 Lakh and up to ₹2. 4 Lakh to be on the safe side. Let us now understand with the help of a case study that if you want to build your emergency fund, then how can you start that process?
A case study on how to build emergency fund:
(1) Let's go to the Google Sheet. Anu is working in a startup in Bangalore for 1 year. Anu's monthly income is ₹ 50,000. Anu pays rent of ₹ 12,000 per month for the PG. Anu has recently taken a secondhand car with a loan equal to ₹5 lacks by paying a downpayment, for which her monthly installment is ₹8,000. In addition, she spends ₹2,000 on utilities, ₹3,000 on groceries, and ₹3,000 on outings and eating out with friends every month. And since Anu follows Groww on YouTube, she knows the importance of investment and insurance. So every month ₹2,000 goes towards insurance premiums, and ₹5,000 towards mutual fund SIPs.
(2) Then what were the total monthly expenses of Anu? ₹35,000. But remember what I said. In the emergency fund, we will consider only the necessary expenses. Hence, we will not count the SIP of ₹5,000 and the leisure expenses of ₹3,000. So, Anu's need-based expenses are ₹ 27,000. So Anu will have to spend 6 times ₹27,000 = ₹1. 62 lacks to create an emergency fund to cover 6 months of expenses.
(3) In this Google sheet, our team has also added the calculation of the emergency fund for 12 months, but for the sake of understanding, I will only talk about 6 monthly funds. Now it is obvious that suddenly it is not easy to raise such a huge amount, that too when Anu can only save ₹ 15,000 per month. Above all, Anu Pure's pure ₹ 15,000 will not be invested in the emergency fund, this too did not make sense. Lastly, our life doesn't run on spreadsheets, expenses will keep on going up and down. So suppose Anu decides that she will invest ₹ 10,000 every month in an emergency fund, then in this case it will take her 16 months, that is, about 1. 5 years to build an emergency fund.
(4) It's been a long time, hasn't it? Let us take case 2. Anu thought why not temporarily cut down on going to Friday night parties, and halve her SIP amount? So they will save ₹ 1,500 and ₹ 2,500 i. e. a total of ₹ 4,000 extra. That is, now she will be able to invest ₹ 14,000 every month for the emergency fund. It will take a little less than 12 months to build up your 6-month emergency fund.
(5) Come on, now the goal is looking a bit achievable, it has come within a year. So brother it is India, festivals keep on going, and relationships keep on coming and going. Suppose Anu received a total of ₹10,000 from her relatives and parents during the festive season, and also an annual bonus of ₹50,000 for doing very well in her job. So if Anu puts this additional lump sum amount of ₹60,000 in her emergency fund, now we only have to invest ₹1. 02 lakh. It will be done in just 7 months at the rate of ₹ 14,000 per month. Isn't it amazing?
(6) With just a few months of extra effort, Anu's emergency fund will be ready in just 7 months! If you want the link to this Google sheet, you can check the description of the video, we have added the link to the sheet there. You can see all the calculations according to your income and expenses by simply copying the sheet. And if you're enjoying this video so far, hit a like and subscribe to the channel because I'll keep bringing you more fun videos like this! Come on, now the time has come to know where should we park the emergency fund money.
Where to invest emergency fund?
(1) Before I tell you about the investment option, let me explain a few things. Number 1: Emergency fund means that we can need that money anytime. Therefore, whatever instrument we put our emergency fund money in, it should be highly liquid. That is, whenever we want, we can access that money without any charge. Hence government schemes like PPF and NPS will not qualify for this as they have lock-in periods.
(2) Number 2: Our emergency fund should be safe so that we have complete capital available when needed. That means we cannot invest emergency fund money in volatile instruments like stocks and equity mutual funds. And No. 3: Being low volatility and highly liquid, our emergency fund should at least keep pace with inflation. That is, the post-tax returns of the emergency fund should be slightly better than the average inflation rate.
(3) Slightly better because if the volatility in an investment option is low, and liquidity is high, you cannot expect high returns. All clear till now? So, now I am telling you 3 investment options. You can open a separate savings account to park your emergency fund. But it doesn't end here, as a normal savings account won't even give you inflation-matched returns.
(4) You have to activate the sweep-in facility in your account. With this, any amount in your account above a limit is converted into a flexible fixed deposit, which you can withdraw at any time. That is, FD returns with the flexibility of a savings account. These 2 types of debt funds invest exclusively in debt instruments of large corporates. The risk here is low to medium, but your returns are also slightly better than inflation here.
(5) Liquid funds are considered relatively safe among all debt mutual funds, and more advisors recommend them as a preferred instrument to park emergency funds. Along with this, they also give more returns than the savings bank. Please note that in the case of debt funds, it may take 1-3 working days for you to redeem your funds! Nowadays mutual fund houses have started providing ATM card facilities to investors, using which they can withdraw a certain amount per day. For example, Nippon India Mutual Fund.
(6) Last, but not the least, you can use any one of these 3 options or a combination of them. For eg, a conservative individual can invest 50% of his emergency fund in a savings account, 25% in a liquid fund, and 25% in a corporate debt fund. Remember that building an emergency fund is not a one-time process.
Conclusion:
(1) You should re-evaluate your emergency fund requirement with your changing income and expenses and add money accordingly. Then gradually you can increase your 6 months emergency fund to 12 months expenses. And yes, in this journey you will feel like taking the latest iPhone or smartwatch, but maintain discipline. You don't have to stop enjoying life, but following a disciplined approach for a few months can go a long way in your personal finance journey.
(2) With this, let's end today's post. If you feel that you have learned something new and practical from this, and have added value to us, then do like the post and subscribe to Groww channel, so that we get the motivation to keep bringing such informative post for you. According to you which investment option is best to park emergency funds?
(3) Or if there is any other option that I have missed, do let me know in the comments. How big an emergency fund you personally have created or want to create, also tell me in the comments. Remember, do not take any investment option in this post as investment advice, and do your research before investing your money. to the Groww website for more such educational and market-related updates.Bye.
