Here’s how I built my emergency fund and became worry-free
The end of the year is a time for celebrations and festivities. But, December 2018 was a different story for me. Two incidents occurred, which were eye-openers.
- Out of the blue, I had to undergo minor surgery, and
2. Just the day before I was to be admitted to the hospital, I had a minor car accident.
While luckily, both incidents had no significant health implications, they both came at a reasonable cost to my pocket.
Despite being well covered under respective insurances, these incidents left me wondering — what if something major had happened to my family or me? I must confess to feeling insecure and embarrassingly unprepared financially. Hence, my first financial goal for 2019 was to build a ‘rainy day fund’ aka an ‘emergency fund’.
Why exactly did I feel the need for a rainy day fund?
Of course, in tough times, I could lean on my friends, family and my credit cards for financial support. But an emergency fund signified much more. It was a way of taking charge of my finances for my family and myself — not only could I lean on me, so could my family. This fund was also my security blanket, should similar unforeseen situations come up again in the future.
What exactly is this emergency fund? This fund is readily available (or liquid) when crisis strikes. This fund could be defined as the ‘backbone’ of any financial plan because it gives the flexibility and freedom to plan for any long-term and short-term goals confidently.
When would I use this fund?
- In case of medical emergencies — my own or my family’s
2. In case of losing a job or when my regular cashflow gets disrupted suddenly
3. Unexpected time off from work due to a family situation, such as caring for my child or parents
4. Unexpected major home repairs or loss of assets
What the emergency fund is not
This fund is not linked to a pre-planned goal like a car, a house, a fancy new gadget or my child’s education. Also, it is a fund that I would not use for any situation that is not an ‘emergency’.
How big should the emergency fund be?
Financial planners worldwide suggest having 3 to 6 months of expenses parked aside for emergencies. While this is good thumb rule, the amount varies based on individual situation and preferences.
The idea of this fund is to bring peace of mind and buy me some time to tide over a difficult time without distress.
How did I decide the amount of emergency fund?
I simply tabulated my monthly expenses into two parts :
- Fixed costs: rent, utility bills, basic groceries, child’s education and extracurricular activities, house staff salaries, monthly SIP, and
2. Variable expenses: recreational activities such as movies, dining out, gifting, shopping, and other indulgences
Taking 100% of my fixed monthly expenses, and 20% of my variable costs, helped me get a total monthly expense. These were expenses which I would not compromise on, even if my cashflow stopped from tomorrow. After that, I chose to save four months of the above amount.
I must admit it was not a small amount to save. But being determined, I put all extravagance on hold and became hawk-eyed on my expenses. Slowly, the savings started building up. Within four months, I was sitting pretty on a handsome cushion of cash!
Where to park the emergency funds?
To keep it easily trackable, I started putting the emergency fund into a different savings account. As the fund became robust, I decided to look for options to invest in this fund. What I wanted was a product, which was quick to redeem, at no penalty, with better returns than my savings bank account.
Below is a simple comparison of the savings bank account versus bank fixed deposit versus liquid funds that helped me make the decision:
Given the above, I decided to bifurcate my emergency fund as follows to maximise return and ensure availability:
The Final Steps
After putting the basics in place, I have decided to review this fund at the beginning of every year. Knowing I have a safety net has also given me a better risk appetite to invest in my long term goals.
A lesson learnt the hard way, but one that is sure to be passed on to my daughter.
On the Basis app, you can create your emergency fund in a few simple steps. You plug in your goal amount, factor in the time when you require that amount and watch how simple it is to get to know what it takes to make that emergency fund.
