November turned out to be one long month for Chennaites and most people in Tamil Nadu due to incessant rain. We were not affected by the rains much, but my desktop (technically my sons) and my laptop broke down in the space of 5 days. We had already spent too much money in handling minor to major repairs and had no choice but to replace them. So thanks to our emergency fund, ‘normalcy’ was restored soon enough. You know what they say about when it rains, … it pours!
Some thoughts on how to handle financial emergencies.
Not all emergencies are bad! Although the purchase of two new computers in under a week set me back significantly, the outcome was pleasant enough. We got two new systems with HD screens (freefincal looks small, but movies much, much better!) and bigger RAM. I was crashing my old laptop by keeping 15 programs on at the same time. I can now do that a bit more comfortably.
If you are wondering if buying a new computer is really an emergency, then I can assume that it is one to us!
Good financial emergency or bad financial emergency, money is money.
The only requisite for an emergency fund is immediate liquidity. We don’t care about returns or tax. Returns and tax matter to those who do not get emergencies. We are not so fortunate.
There are several ways to handle financial emergencies. Here a few:
A stash of at least 6 months expenses divided among a
SB account (instant liquidity)
E-FD (also instant liquidity – break it and it goes to SB acct)
Liquid fund (not as liquid as the same sounds. May take up to 48 hours depending on when you redeem)
It is better to have different layers to an emergency fund:
The SB account can be used to small ticket and common emergencies (eg. washing machine or TV breakdown). The e-FD and liquid fund for more big-ticket rare emergencies.
I like this approach because I hate using a credit card (don’t have one. Use my wife’s if I have to). For those who don’t mind using a credit card for emergencies, a liquid fund or an ultra-short-term fund is not a bad place for emergencies. Of course, one must use the card only if one has the ability to pay in full before the deadline. You would be surprised how many are not aware of this basic fact.
Note: There are instances in life where a credit card cannot be used. The merchants swipe machine may not work or the magnetic encoding in your card could have been corrupted. So it is best not to take it for granted.
Ability to replenish an emergency fund is as important as having an emergency fund. About 5-10% of our monthly salary can be routed to the emergency fund forever! To some extent, this will take care of withdrawals. Read more: How Long Should I Maintain an Emergency Fund?
“Six months expenses" is only a thumb rule! Don’t believe it. You need more! A lot more. A single hospitalization is all it takes to learn the hard way. Whether you cover it with a corporate cover or individual mediclaim policy, you will need about 10-15% of the bill to cover for “non-medical expenses". These include any non-medicinal accompaniments like gloves and personal care products. Such extensions could continue even after the patient comes back.
An EMI stash: Losing one’s job while servicing or should I say serving a home loan sentence is the nightmare of anyone in a corporate job. Keeping about 2-3 month’s EMI stashed away, perhaps in an arbitrage fund seems like a good idea.
But for an emergency fund, the first victim would be the amount allocated for long-term investments. Emergency insurance is mandatory. Even for those who do not need life or health insurance.
The worst kind of financial emergency is an unexpected recurring expense. An emergency fund will not help you there and money management will go for a toss. When my mom fell down and broke her in Feb 2014, I had hire a nurse to tend to her in the day. Therefore monthly expenses suddenly increased by a significant amount. Investing enough for long-term goals became a challenge. It still is, but I am afloat .. for now.
End note: About ten years ago, when my late father was hospitalized for the first time, I was a head in the clouds academic. We had no health insurance and no emergency funds. My brother-in-law gave us an interest-free loan of 1 Lakh (for a start!). That was the first time I ever saw that much money. I told myself I should never ever find myself in such a situation (borrowing from relatives). It took me more than 5 years to get there (at least I think so). Everything needs a spark and that was my spark to learn about personal finance.