Emergency Fund: Things You Didn't Know You Didn't Know
Life is a mystery; you never know when a curveball is headed your way. Sometimes you may hit the ball out of the park, at other times you may not be as lucky. For those unpredictable times when things are out of your control ensure you have a safety net to fall back on.
In financial terms, this safety net is your emergency or contingency fund. As its name suggests, an emergency fund is accessible wealth that can be used as a saving grace when the flow of your income stops or is interrupted. A pause in income could be due to various reasons; unexpected hefty expenditure due to an accident or health issues, turmoil in business, or even job loss.
The top reason today is the pandemic. The economic standstill that is lurking has brought with it uncertainty, in terms of normalcy to both life and business. The allowance of bare essentials today has caused a slowdown in business activities, job losses, and is likely to have a cascading effect on each of us in the near future. At a time like this, when the return to normalcy is unpredictable, having an emergency fund ensures your basic needs and essentials are covered giving you a sense of security and peace of mind.
Where to begin?
The first step to financial freedom is securing your future; creating and investing for retirement or education without having a contingency fund in place is not the right move. In such a scenario, if any critical situation should arise you may end up dipping into your retirement or child’s education fund instead. This could be at a cost of paying a penalty for early withdrawal, at the loss of interest and added tax implications which defeat the purpose of the investment. Such a catastrophe can be avoided if one sets aside some amount to build a corpus for troubled times.
By rule of thumb, the ideal fund is an equivalent amount that covers 3 to 6 months of essential expenses. Individuals running businesses will have to increase that equivalent to 12 months of expenses, this helps safeguard the volatility in receipt of payments that businesses usually face. Here, essentials include food, rent, EMIs, essential bills, fees (school/tuition), medical expenses, etc. Begin by calculating the bare minimum you and your dependents spend on essentials each month, multiply that figure by 3, 6, or 12 and there you have the ideal amount for your contingency fund.
To ease the process, answer these questions:
· What are my essential expenses?
· How much of disposable income do I have?
· How much time will I need to gather this corpus?
· Where can I cut corners to speed up the process?
Parking your corpus
The idea of creating a fund is to dip into this corpus specifically in times of unexpected emergencies; this does not mean you have to set aside this amount in hard cash that’s just sitting there. Idle cash earns you ‘zero’ gains and loses its value in inflation. It is prudent to park these savings in liquid assets that can be easily withdrawn in 24 hours or two working days at least.
Assets like real estate or ones that attract penalties for withdrawal before a fixed tenure are certainly not the best option for a contingency fund. Instead, you may choose assets like fixed deposits, short term RDs or debt mutual funds, etc. Gold is another good investment which can be liquidated instantly utilizing a gold loan. Such funds are convenient, flexible, and secured guaranteeing accessibility in times of urgency.
The importance of an emergency fund cannot be stressed upon enough. During turmoil and financial instability, people tend to reach out for quick loans from relatives, banks, friends, colleagues, or even local money lenders. The feeling of being indebted to someone, family or not, especially when you are in the middle of a financial crisis can be utterly burdensome. Avoid this hassle in the future with a little prudence today. Begin your journey to financial freedom with Alphabet Investment, one step at a time.
Do you have a safety net set up to secure you from a future financial crisis? Is it enough to see you through? Here we address questions about establishing an emergency fund to cover you and your loved ones from financial crashes.