Utilizing a rough rule of thumb You need to have your six months of expenditures prepared. We have already talked there can be any form of emergency and none would let you exempt your EMI or Rent. If you don’t want to make a drastic negative shift in your lifestyle, just because of unpreparedness for an emergency, then make sure to include every single monthly expenditure. If you are ready to follow the cash inflow system, then in few months you will get a rough figure that you require every month. This estimated amount will include Rent, EMI, Living Cost, Travelling Cost, Lifestyle expenditure, fees, bills, etc. You just need to multiply this figure by six (as you are preparing an emergency fund for six months).
Preparing for six months is just an idea and you can modify the duration as per your situation. Your preparedness depends on the number of dependent members. Say, you and your spouse are working and no one is dependent on you two. In such a situation saving for 3-4 months seems enough as the probability of both of you losing your job is very low. But if in the same scenario, one of you is managing monthly EMI and the second one is handling living costs, then you should extend your emergency fund covering six months.
If you are the sole earner of your family and have your children, wife, and parents dependent on you, in such a situation accumulating one year of the emergency fund makes sense. The main motive of establishing an emergency fund is to feel carefree. So it is completely dependent on you – it is your task to make yourself feel free. Many are averse to taking a risk when it comes to the emergency fund and prefer being over-prepared. Some save for one year of living cost in emergency fund. This phenomenon will empower you in taking bigger risks when it comes to investment.
Where to keep Emergency Fund money?
An Emergency Fund should be readily available and should be safe somewhere. When I talk about readily available, don’t even think of keeping the stash of cash at home. Obviously, you can’t keep your months of living expenditure at home. What if it gets stolen? What about value addition? You won’t get any interest for keeping the cash in your personal safe. Now, if you are thinking of keeping the money in a Savings account and enjoy 4% annual interest, then let me tell you my friend that it’s slightly better than keeping money at home but still it’s not the best option. You need to look for something which is not that comfortable to access but still liquid enough to be used at the time of emergency. Also, we want better returns to maintain the original value of our money.
The easiest and most straightforward banking product to preserve our emergency fund is FIXED DEPOSITS. Our elders have always advised us to get our money fixed. Guess what? They are not totally wrong. Getting money fixed is a good option to keep the money safe. But it is not preferred if you want your money to grow. When you know the objective of your money, product selection becomes very easy. Another option for keeping the Emergency Fund safe is Short-Term Debt funds. There are wide range of products offered under Mutual Funds and some of them are suitable for building Emergency Fund and keeping them safe.
There are many benefits of Debt Mutual Fund such as higher return, more liquid than Fixed Deposits, lower tax on interest, etc. Let person – A has to prepare his emergency fund. He is a sole earner with a monthly income of INR 1 Lakh. His family of 4 members is dependent on him and he has to pay a monthly EMI of INR 15,000 as well. Clearly, he needs to have a year of living cost (which must be around INR 8 Lakhs) in his Emergency Fund. Saving INR 8 Lakhs with a monthly salary of INR 1 Lakh and a bunch of other expenses will definitely take time. By setting a monthly target of transferring a fixed amount each month this target can be achieved. Once it’s done, A would be free to move his focus towards long-term investment.
You have to do the same. Once you achieve the target, just stop funding the emergency fund and keep it aside in Debt Mutual Fund. Once your emergency fund and insurances are at its place, you can live life carefree.