Establishing an emergency fund is the initial step in achieving financial stability. The amount of funds needed for emergencies cannot be calculated accurately as it varies based on personal outlook. It depends on the individual’s experiences with unfortunate events and their frequency, whether positive or negative.
It’s important to note that experts recommend having an emergency fund equivalent to 3-6 months’ worth of expenses, primarily for those who currently don’t have any savings. While a fund of this size helps cover certain unforeseen expenses, such as job loss, and car or appliance repairs, it has limitations. It’s essential to remember that the term “expenses” encompasses all EMIs wrt an emergency fund.
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 life’s problems.
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 discussing health insurance like it is some 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 it is often rejected! This implies that the patient must pay the bills and then make a reimbursement claim (hoping it will be honoured!).
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With medical expenses increasing annually at an alarming rate (15-20% is a conservative estimate!), would an emergency fund worth just 3-6 months of expenses suffice under such circumstances? Having liquid cash worth at least 50% of your mediclaim cover is prudent. 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 will not die anytime soon, and/or if they do die, all their nominee has to do is 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 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, the 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 settle the claim successfully. The nominee can handle the claim settlement process calmly and clearly. 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 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 great certainty is that the emergency fund will be a central part of ensuring your financial independence in retired life. When you are employed, a car breakdown is less serious than a pink slip. A pink slip is less serious than death. Such distinctions are harder to make 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 two years of expenses during retirement would be needed, in addition to a decent corpus for medical emergencies alone! If your retirement is a few decades away, you have time to build this. Just get started!