4 MinsMarch 25, 2020
If you know the importance of having an emergency fund, but don’t know how to get started, begin by listing your regular monthly expenses.
The quantum of your emergency fund (also known as a contingency reserve) should be determined based on factors such as:
- The regular monthly unavoidable expenses to run your home, namely grocery bills, utility bills, routine pharmacy bills, regular health check-up bills, children’s school fees, property tax, water tax, rent (if you live in a rented house),
Equated Month Instalments (EMIs), insurance premium, among a few others
- Certain lifestyle expenses
- The responsibilities you are shouldering, that is, financial obligations towards dependent parents, spouse, and children
- Other liabilities
- Assets you own that can be monetised should an emergency arise
By doing this you will be able to estimate the amount you need to maintain in your emergency fund, in case you lose your job, confront a medical emergency, face unexpected expenses, such as car breakdown, home repairs, a sudden rise in your child’s
school fees and so on.
Broadly the rule you may apply to build an emergency fund is:
Contingency Reserve = 12 to 24 months of regular monthly unavoidable expenses including EMIs
So say, your regular monthly unavoidable expenses, including EMIs, are Rs 60,000; then the minimum amount that you should hold as contingency reserve should be Rs 7.20 lakh, while on the upper side Rs 14.40 lakh.
You may add a little 5%-10% extra for medical emergencies, taking cognizance of your and your family members’ health insurance and medical history.
Besides, ensure you have adequate life insurance and health insurance cover. After all, contingency planning is based on the premise: Hope for the best and be prepared for the worst. Ultimately, the objective is to have a sufficient emergency
Where to park the emergency fund?
Here are a few avenues to consider…
1. Savings Bank Account - A portion of your contingency reserve can be held in a separate savings bank account, earning interest at the rate of 3.5%-6% per annum, as opposed to it
lying idle at home. This will ensure easy access to your money, during an emergency. You can easily make payments online if you have an internet banking account.
2. Term Deposits or Fixed Deposit– If you wish to counter inflation by earning a slightly better rate, some portion of your emergency needs can be parked in a term deposit. A term deposit is a meaningful choice. It offers
fixed and secured returns, meets liquidity needs (if the plan and tenure are thoughtfully selected), can be linked to financial goals, and it is also possible to avail a loan against the term deposit rather than prematurely withdrawing the deposit.
In addition to a regular bank FD, Axis Bank offers a couple of variants such as Encash 24 Flexi Deposit and Fixed Deposit Plus with distinct features. Opt for the one that suits you the best.
3. Debt & Money Market Mutual Funds – Debt mutual funds invest in fixed income securities such as bonds, corporate debentures, Government securities, and money market instruments. These are a good option for funds that
you may want to access at short notice. They are less volatile than equity funds. But remember that debt funds also carry interest rate risk, credit risk, liquidity risk, price risk, macroeconomic risk, and so on. You may consider overnight
funds, liquid funds, ultra-short duration funds, low duration funds, and money market funds to park a small portion of your emergency needs.
Your emergency funds should be held in a mix of the above avenues in the right proportion. The objective should be not to clock high returns, but liquidity and safety of the principal while yielding nominal returns.
Further, as time passes, a review is necessary to correct under-allocations, and at the same time, account for certain situations that may have bearing on your emergency fund.
If you haven’t built an emergency fund, start right away using Axis Bank’s Emergency Fund Calculator, because life’s unpleasant surprises often come without any forewarning.
Also Read: [Personal Loans: A backup for your emergency needs]
Disclaimer: This article has been authored by PersonalFN, a Mumbai based Financial Planning and Mutual Fund research firm. Axis Bank doesn't influence any views of the author in any way. Axis Bank & PersonalFN shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.