Last Updated on January 16, 2021 at 6:35 pm
In this article, Sarthak Parikh explains the importance of an emergency fund; how much is necessary; where to park it and how the pandemic has increased the need for a robust emergency fund.
COVID-19 has hit us all hard in ways that we had never envisaged. The fear of losing a job if you are an employee or losing your business income if you are an entrepreneur has never been as real as it is at this point in time.
I live in Ahmedabad, the financial capital of Gujarat and India’s 7th largest city. It does not have a nightlife due to obvious reasons known to everyone but what it can boast of is lots of good restaurants, cafes and thali places.
I can vaguely estimate that 2019 was the year when an unprecedented number of these places burst into the Ahmedabad food scene than any other year in the past. However, with the most stringent lockdown that had hit all of us this year, the number of these newly opened food joints that have shut down in the last 3 months has also been huge.
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I am sure you can paint a picture in your head now. Most of the staff being laid off, budding entrepreneurs who invested their monies forced to shut off their dreams. In these unforeseen emergencies, emergency funds give you a much-needed cushion. Imagine if you stumble upon an oasis in a desert when you had absolutely no water to get through your days of arduous travel. An emergency fund is that oasis in the world of personal finance, the one which will help you tide over tough times.
I am a person with no background in finance. But ever since I landed my first job, I have made it a point to read as much as I can on personal finance. What I do know is of the basic pillars of personal finance emergency funds are amongst the most important. Even an amateur science student in me understood in 2013 that after getting a Term and a Medical cover, you should put all your might into gathering that coveted emergency fund.
It took me 2 years to gather my emergency fund after landing my job. I kept aside a fixed sum of money every month for 24 months. There have been plenty of instances wherein I have seen friends and relatives struggle with unforeseen circumstances wherein there was a requirement of urgent money.
However, due to lack of proper financial planning, they had to take the help of other people. This is one of the most unfortunate situations an individual can find him/herself to be in. An emergency fund will help you in scenarios like these and save you from embarrassment.
There are different points of view on how much money one should put into an emergency fund. Experts are of the opinion that anywhere from 6 months to 1 year of your monthly expense should be the amount that should be kept in an emergency fund. I would not like to debate on what the experts say, but I have a slightly diverse view on this.
I am of the opinion that one should have that much amount in one’s emergency fund that lets one sleep at night peacefully without fearing for a job loss or an impending medical emergency. This amount can be your 1-year expense or your 5 years worth of expense; the decision is solely based on you. Another aspect that can also be taken into consideration is also on having faith in your skills and abilities. Imagine if you were fired from your job right now, considering your experience and your skillset what would be the timeframe that you would need in getting a new job? Answering questions like these will help you in deciding on your emergency fund. You can also factor in your monthly SIPs along with your expenses when you are building your emergency fund. Hampering your investments even for a short duration of time can have an effect on your final corpus.
Personally speaking, even with absolutely no impending doom of a job loss, I would be lying if I said the fear of losing it did not cross my mind. COVID-19 has shattered some of my previous notions on emergency funds. I have used this time to divert parts of my salaries in strengthening it. Redeeming equities during emergencies is a bad idea. You will be seriously hampering the compounding, and you will be putting your goal achievement in jeopardy. Having some funds parked safely and separately for a rainy day is extremely important.
Where should the emergency fund be parked? Savings bank account, Fixed deposits, Liquid funds are some of the safest options, and more importantly, they are liquid. You should have access to your funds in an extremely short period of time. Returns are not a criterion in choosing where to park the emergency fund, safety and liquidity is. So do not run after that extra 2% return where your capital is put at severe risk. When it comes to your emergency money, it is better to be safe than sorry.
I go back to my initial thoughts on those employees who have been laid off and the entrepreneurs who had to give up on their dreams and shut off their restaurants. I am not a soothsayer, and I cannot predict that having emergency funds would have been the answer to all their problems. However, I do feel they would have slept peacefully if they had some amounts saved for a rainy day.