A reader asks, “At what percentage of networth can I stop contributing to Emergency Funds and include it in my debt allocation for goals? For example – I use a liquid fund and an arbitrage fund for emergency funds. And I use a gilt fund as debt allocation for my retirement goal. When can I stop contributing to liquid and arbitrage and divert my contribution to the gilt fund?”
It may not seem so at first sight, but this is a deep question and not so easy to answer. How big should be an emergency fund? You will find answers like “three months expenses worth”, “six months expenses worth, “12 months …” etc.
The truth is, no one knows how big an emergency fund should be. Experience teaches us that we can’t decide that! It is up to the emergency! An emergency costing Rs. two lakhs with an emergency fund of Rs. one lakh would mean the extra one lakh will have to be handled by redeeming other investments meant for goals or handled via income or, worse, via loans.
So all an emergency fund can do is, handle reasonable commonplace emergencies when we have just started investing and ensure that at least the amount already invested has a chance of growing untouched. If we are lucky not to court emergencies during the first five years of investing, we will be reasonably placed financially.
Once our net worth has grown much higher than the emergency fund, our entire net worth becomes the emergency fund! That is, we can handle even large emergencies without borrowing.
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So to answer the reader’s question, if you think your current emergency fund is big enough to handle typical emergencies like hospitalization for a couple of days (remember that sometimes we may need to pay first and then get it reimbursed from the health insurer and even for cashless claims at least 10% of the total amount will not be covered by insurance as they are “non-medical” in nature) or vehicle repairs or appliance changes etc.) then you don’t need to contribute to it.
How much is enough is a subjective issue. Some are okay with six months’ expenses worth. Some with 15 months or 24 months’ expenses worth. It depends on personal circumstances like how stable your income is, how much surplus you are left with each month if you are servicing any loans etc.
So ask yourself what amount of emergency cash will make you sleep better at night and focus on building that. You can postpone investing until then.
In any case, after the next emergency, you will have to restart contributions! Be mentally prepared to treat your entire net worth as an emergency fund! God willing, it will never come to that.