Last Updated on December 18, 2021 at 10:48 pm
This intriguing question was recently asked by my friend. Intriguing because it can be answered in two ways:
- In one word!
- Or by considering all possible ways an emergency fund would see some action!
By action, I of course refer to emergencies only! American financial coach Dave Ramsey, often says, “Christmas is not an emergency!”
Setting up an emergency fund is the first item on the fiscal fitness checklist. Just how much should the emergency fund be? You can’t make a calculator to address this one! It depends on whether you are a pessimist or optimist! It depends on the kind of bad things that have happen to you or to people you know and the frequency of their occurrence!
When experts say that one needs an emergency fund equal to about 3-6 months expenses, it must be kept in mind that they are addressing people with zero emergency fund so that something is better than nothing. An emergency fund worth about 3-6 months expenses is not bad at all but will only handle a limited range of emergencies: keeping you afloat for a few months when the dreaded pink slip arrives (ably supported of course by a severance package, assuming you receive one!); car repairs, appliance repairs and the like. In this context it is very important to remember that ‘expenses’ includes all EMIs.
Join 32,000+ readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email! (Link takes you to our email sign-up form)
🔥Enjoy massive discounts on our robo-advisory tool & courses! 🔥
Most people are under the impression that such an emergency fund (3-6 months worth …) along with adequate pure term life insurance and adequate health insurance (employer based +/- private) is enough to tackle all the problems that life can throw at you.
Such people have either been lucky (so far) and/or are too young to have experienced/seen/heard of anything bad. Good for them. Unfortunately, past performance is not … well, you know the drill!
Most people use the term ‘cashless’ when health insurance is discussed like it is some soft of panacea – the cure for all hospitalization related money issues. A cashless claim is just one way of claiming hospital bills and is applicable only under certain circumstances. An insurer has to permit a cashless claim before treatment is started (other than basic first aid and stabilization) and is often rejected! This implies that the patient will have to pay the bills and then make a reimbursement claim (in the hope that it will be honored!).
With medical expenses increasing annually at an alarming rate (15-20% is a conservative estimate!) would an emergency fund worth just 3-6 months expenses suffice under such circumstances? It is prudent to have liquid cash worth at least 50% of your mediclaim cover. Since it is important to increase the mediclaim coverage annually by as much as you can, the same applies to this segment of the emergency fund!
Many who take term insurance believe that they are not going to die anytime soon, and/or in case that they do die, all that their nominee has to do is to make a claim application and the insured amount will be dispensed forthwith! I would strongly urge such people to read this: The Games Life Insurers Play!
Never forget this: Term insurance is the cheapest of all insurance plans. At the same time, the sum insured in a term plan is the highest. Therefore it is will be subject to close scrutiny. Therefore delays in claim settlement are quite common for a variety of reasons (how one dies, when one dies, nominee dead or injured etc. etc. etc.). So when you take a term plan ensure that, over a period of time, you slowly build an emergency corpus that will cover at least 12-15 months of expenses in the event of your death. Hopefully this buffer will provide enough time for all parties (insurer, nominee and ombudsman, if needed) to get the claim settled successfully. The nominee can handle the claim settlement process with a calm and clear mind. Even if for some reason the claim is not settled it allows your loved ones some time to arrange for alternative sources of income.
If you think that an emergency fund is a like a guardian angel on part time duty when you are employed, you are right. Provided of course you realize that the moment you retire, the guardian angel is promoted to a full-time employee! Every retirement calculator is based on assumptions and unless you get close to retirement it will not be possible to predict with any accuracy how much you actually need to generate an adequate pension/annuity to sustain you.
What can be said with a great degree of certainty is that the emergency fund will be a central part in ensuring your financial independence in retired life. When you are employed, a car break-down is less serious than a pink slip. A pink slip is less serious than death. Such distinctions cannot be made in retirement. When you are retired, any unexpected large expense will slowly but surely eat up the life of your retirement corpus. So I would like to conservatively guess that an emergency fund worth about 2 years of expenses during retirement would be needed, in addition to a decent corpus for medical emergencies alone! If your retirement is a couple of decades away, you have time to build this. Just get started!
To summarize, here is my version of a decent emergency fund
- Sum equal to about 3-6 months emis. Leave it be even after you are debt free!
- Sum equal to 12-15 months household expenses. Six months to start with and then built up slowly
- Sum equal to at least 50% of mediclaim sum assured. Requires constant contribution!
- Any excess funds after accounting for investments and expenses (in that order!). Contributions lasting a lifetime!
- Use simple products like a savings bank account and liquid fund for meeting everyday emergencies. Avoid complicated products like sweep-in (FD-linked) bank accounts. Remember returns are not important for an emergency fund. Safety, liquidity and simple tax rules are.
Never, never forget:
Investing for retirement and a corpus to meet medical emergencies in retirement are non-negotiable financial goals of utmost priority.
Always, always remember:
I started the post by stating that the titular question can be answered in one word. What do you think that is ? Do you agree with my version of the emergency fund? Do you think I am bit too pessimistic?
🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 7000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! ⇐ More than 2,500 investors and advisors use this!
Track your mutual funds and stock investments with this Google Sheet!
We also publish monthly equity mutual funds, debt and hybrid mutual funds, index funds and ETF screeners and momentum, low-volatility stock screeners.
- Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
- Have a question? Subscribe to our newsletter using the form below.
- Hit 'reply' to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.
Join 32,000+ readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email! (Link takes you to our email sign-up form)
About The Author
Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free! One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course! Increase your income by getting people to pay for your skills! ⇐ More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!
Our new book for kids: “Chinchu Gets a Superpower!” is now available!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Do you want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or get the Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & its content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
- Twitter @freefincal
- Subscribe to our YouTube Videos
- Posts feed via Feedburner.
Our publications
You Can Be Rich Too with Goal-Based Investing
Published by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want
This book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.Your Ultimate Guide to Travel
This is an in-depth dive into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically, with links to the web pages and hand-holding at every step. Get the pdf for Rs 300 (instant download)