The first and second waves of Covid, which hit salaries and jobs and livelihoods in a big way, hammered in the fact that it is important to have an emergency fund in place. With the Omicron variant of Covid presenting a new threat, it is better to be prepared in advance. So, if you do not have an emergency fund in place already, it’s time to build and keep aside one.
“An emergency fund is an inevitable part of the portfolio of an individual. It is essential in order to meet the unplanned and unexpected liquidity needs or requirements which may arise in one's life journey,” says B Srinivasan, certified financial planner and director of Shree Sidvin Investment Advisors, a Sebi-registered investment advisor.
Here are three things to keep in mind when creating an emergency fund to tide over tough times.
Know Your Expenses
To build an emergency fund, you need to be disciplined. “We suggest allocating a part of your investments/savings for the emergency fund till the emergency fund target is achieved. One can set aside a part of the monthly savings or a portion of the bulk/ad hoc surplus one generates,” says Srinivasan.
To create an emergency fund, you must analyse your expenses and arrive at the committed monthly expenses. You must then segregate the same into necessary and unnecessary expenses. For example, eating out or buying things that you don’t really need could be clubbed into the unnecessary expenses bucket.
This will help you realise how much your actual expenses are. You could relook at your expenses in the past three to six months.
Estimate Your Requirement
The amount of emergency fund may vary for every individual, depending on many factors such as the number of dependants, their health condition, age, income, lifestyle, and so on.
While salaried people should have six to nine months of their monthly expenses, self-employed people (such as doctors and lawyers) should have at least 12 months of their expenses as their emergency fund. For entrepreneurs, the corpus could be anywhere between 18-24 months of their monthly expenses.
“As a thumb rule, we generally suggest having an emergency fund which covers six months of one's current committed expenses. Post the pandemic, we are suggesting an emergency fund to cover one's one year of expenses. Further, as people are now worried about their health issues, a reasonable contribution towards their emergency health requirements can also be provided for,” adds Srinivasan.
Start Building A Corpus
Once you arrive at the emergency fund requirement, you could start investing a part of your savings or investments to build the same. While investing for the emergency fund requirement, liquidity should be given priority over returns. Also, this should be your first financial goal in order of priority.
“We suggest having 20-25 per cent of the emergency fund in savings bank account, preferably with a linked deposit facility. The balance can be parked in a tax-efficient option like a debt or hybrid debt fund,” says Srinivasan.
You could also look at liquid mutual fund schemes which yield much higher than savings accounts and have a tax advantage of long-term capital gains (LTCG) post three years.
“Since the last two years were exceptional in nature due to the pandemic and we are all nestled in our houses, it may not be prudent to arrive at the emergency corpus based on recent expenses. Therefore, one has to either look back at their expenses before the pandemic or have to assess the same from now. Preferably one can reassess the emergency funds on a periodic basis, at least once every two to three years,” says Srinivasan.