Building an Emergency Fund
It is important to have a plan in place for any decision you make, especially when it comes to living a peaceful life. With the increasing competitiveness and constant threat of job loss due to advancements in AI, people are experiencing a lot of stress. That's why building an emergency fund can help alleviate some of that stress and provide a safety net in case things go wrong.
An emergency fund is a safety net you build for yourself and your dependents to manage situations or emergencies like job loss, unexpected medical bills, or even home/car repairs, etc. These things come uninvited and it is best to be prepared for them.
Building the Corpus
When building an emergency fund, you need a sum of all your fixed expenses for a period of 3 to 6 months. Although experts do suggest that it is good to keep till 1 year. That is what COVID-19 taught us.
This means the amount you need for sure every month i.e. bills, groceries, and EMIs. Anything you cannot afford to miss. We don’t usually take investments into account, because in cases of emergencies, we usually have an option to pause them till the situation is better.
It should be liquid
Since it is an emergency, it should be readily available. So it is best to keep them liquid or easily accessible. The best way to have it is in cash, but we rarely do cash transactions these days. A savings account is a good option but try to keep them in a secondary savings account so that you don’t start eating into it by mistake.
A Recurring Way
Another option is to start a recurring deposit. An RD provides the same interest as a fixed deposit (FD) but in a SIP form. Indian banks give as much as 7.2% on a 2-year RD as of date. And since you will have auto debit facilities via banks, you will keep depositing into your RD on a monthly basis without even realizing it.
It is not wise to break your retirement investments in case of emergencies as you might end up losing making a huge profit. Retirement is not an emergency. It should be a well planned decision.
The Tax Refunds
Another way that we usually forget to utilize properly is our tax refunds. Companies usually deduct higher TDS than required and we get a major portion of it as a refund due to our deductions. The trick is to park this money into an emergency as soon as it arrives. The reason is you have already learned to live by it throughout the year. So you might as well park it in an emergency fund.
Example
Let us say your bills amount to 20k a month and your loans come to around 30k. That means you need 50k of money to survive every month in case of emergencies. Multiply that by 6 months assuming that is how long it will take to recover from that emergency and you have an amount. i.e. 3 Lacs. Once you have the amount, think how much you can afford as EMI for the RD and you will get the number of months it is going to take to build it.
Penalty and Taxes
Banks do however charge a penalty if the RD is prematurely withdrawn. This is usually in the range of 0.5% to 1% of the invested amount which is still okay if it helps you through tough times. There is also a tax of 10% on the amount if the interest is more than 10k a financial year. You can use this calculator to have a better understanding of how much you need to invest.
Don’t Stop but Revise
Now that you have built your emergency fund it is best to keep revising it as expenses will only increase. So calculate accordingly and keep adding to the fund so that it always covers up for 3 to 6 months. The good thing here is with every passing day your loans will also diminish so this might bring a balance.
We live in tough times and with each passing day it is only getting worse. You can’t prevent an unforeseen situation in life but you sure can plan for recovery. Remember, the easiest thing in life is to Panic. The next easiest thing is to Plan.
