Wednesday, February 12, 2014

Need for emergency fund

Recently on some forum, I saw a person wanting advice if he can withdraw from the GPF for some emergency. I do not know what he did. However, that question made me think about emergency fund.

Photo Credit: Flickr - Eric Flexyourhead

 
Emergency fund is the most neglected area for majority of people. Here, the majority is from the people who invest money. Those who simply stash their money in SB account, they need not read further. For them, their SB account will act as emergency fund. Investors generally put their money in long term MFs, PPF, GPF. Some may argue that I forgot to mention LIC. It does not matter, I am talking about illiquid products. So you may add LIC to that list if you think LIC is investment.
Several people argue that they do not need emergency fund as they regularly exercise and would not be hospitalized. Now, even though this statement is highly controversial, even if we consider true; still that person would need emergency fund. Please note, it is not for a single person as such. Emergency fund is for complete family. A single person staying healthy in family, need not ensure that all are healthy and would not need emergency fund. (Accidents have got nothing to do with exercises. Viral flues, epidemics have got nothing to do with exercises or jogging or gym)

Moreover, we have got enough examples of people excersising regularly and still dying early. Forget dying, hospitalization  is where you would need emergency fund (in death case, you need insurance). 2 months back, my relative had to operated for 15 minutes and the bill was 30k+. Add multiple followups and medicines to that amount. These days, one week of hospital stay would make huge hole in pocket. Health insurance (if bought) may come to rescue. However, they too have their exclusions, limits, caps and terms and conditions.

For such emergency situations, if you disturb/destroy compounding of your long term investment instruments, then the situation gets worse. Hence, it is always advisable to build emergency fund first and then think about investment avenues.

How much amount should be in emergency fund account is again subjective. Thumb rule is to have 6-8 months of expenses in emergency account. As
Pattu says, in some cases thumb rule sucks, get your own figure.

Next question could be where to park the emergency fund. This list can be pretty exhaustive depending upon one's knowledge in finance and lifestyle.

For the beginners, a simple SB account can be your emergency fund account. Here the interest rate earned would be 4% only. For those who are interested to earn more interest, they can park their funds in liquid or arbitrage funds or bank FDs. We also have short term and ultra short term mutual funds which can be used as emergency funds. Just remember that while selecting instruments, returns should not be the first look out point. Liquidity should be first look out. Liquid funds can be redeemed in T+1 or T+2 days. Reliance has come with a money manager mutual fund and an ATM card along with it. This ATM card can be swiped in emergency situations (Note: SHOPPING is NOT emergency).

Some people choose to park their funds in debt mutual funds. Although, they may give better returns, these funds can be risky than those listed above.

Note: For some people, buying furniture, TV, iPhone can be an emergency situation. For them, I do not have any advice (not that they ask me. LOLs)

Read the response I received on this post here


8 comments:

  1. Dear Viren, thanks for providing the important info in a simple yet effective language.

    Thanks

    Ashal

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    1. It was wonderful to have such words from the master himself..... Thank you Ashal

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  2. Very nice written Viren Thanks ...

    Bank FD with short term ( in days ) with handsome amount is very good option i prefer this.

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    1. Thank you Kaustubh.... Yes, you can do that....plenty of options, you can select any of those....

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  3. Few days back one of my friend contacted me through FB and asked me for some financial help .(Around 4/5 k). When I asked the requirement, he told for his mother's some surgery he has spent almost 3L and he is sort of 1.5 L. Then upon asking little more I got to know he has celebrated his daughter's 2nd birthday in a 3 * hotel 15 days back and has spent almost 30K. Also he has some LIC policy, ULIPs. Even he is not bothering to surrender few policies , but asking friends for donations.

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    1. They are everywhere Tapas.... Read feedback on this post from one of my friend who was asking me how can a common man build an emergency fund with home loan and car loan.... His cashflow patter suggest completely different picture.....Problem is not what we have already done, problem arises when we are not ready to learn from our mistakes....

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  4. Thank you for your guidance. Would look into it ASAP.

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