As per Wikipedia – an emergency is a situation that poses an immediate risk to health, life, property, or environment. Most emergencies require urgent intervention to prevent further worsening of the situation. We must always be prepared to manage any emergency situation whenever one arises. Management of an emergency involves four phases –
1. Be prepared for emergency by clearly defining steps to be undertaken when an emergency situation arises.
2. Respond to emergency by executing predefined steps to handle immediate condition arising out of emergency.
3. Recover from emergency situation means taking further steps to overcome the situation that has already happened, and
4. Mitigate the emergency by ensuring another emergency situation of similar type does not happen again in the future.
As part of emergency preparation, an individual or family requires three major things –
1. Emergency funds,
2. Emergency response plan, and
3. People to handle emergency.
What is an emergency fund?
An emergency fund is money held as separate contingency reserve at all times to deal with unexpected situations. During emergency, this fund acts like a parachute to get you safely out of a “crash”. Most important aspects of emergency fund are –
1. Emergency fund should be constantly maintained at all times.
2. Anyone in the family should have the ability to withdraw a part of this money at very short notice (often within a few hours).
3. Emergency fund should not be part of monthly/annual expenses.
4. Emergency fund should not be accounted for as long term savings.
5. Emergency fund should not be invested into –
a. Volatile instruments like stocks.
b. Instruments that are not easy to sell at short notice like real estate.
c. Instruments with a lock-in like equity mutual funds or debt mutual funds.
Who should have emergency fund?
Each and every individual or family must have an emergency fund in order to be prepared to handle the unexpected. However most of us are not prepared to face crisis and very few people think about putting money aside to deal with it. How well one handles unexpected events in life is often the only thing to make difference between meeting life goals.
Where to keep emergency Fund?
Emergency fund should be kept in ultra-safe instruments with easy access at a short notice having no lock-ins. Some of these ultra-safe instruments are –
1. Cash in hand to be used at very short notice.
2. Cash in separate bank account to be withdrawn from anywhere using ATM.
3. Cash in over-night mutual funds or liquid funds with no exit loads.
4. Bank fixed deposits with maturity up to one year.
You can reach out for cash in hand and in separate bank account within few minutes/hour(s) to provide first response to emergency as soon as it happens. You can then move to mutual funds and fixed deposits based on need.
How much to have as emergency fund?
For an individual or family, emergency fund size should depend on ongoing phase in their life, cost of living in their city of residence and time taken to arrange additional funds. It is must to periodically review the amount kept as emergency fund because you will miss out on various investments opportunities if you keep large amounts. Similarly you will face difficulties if the amount kept is small.
Being a contingency fund, it should provide support for you and your family during any unexpected mentally and financially taxing event. It is generally said, one should create an emergency fund that covers your living expense for 3 to 6 months. Beyond this time you should be able to find an alternative solution.Let us look at a few examples –
- Under normal circumstances, if one is earning INR 30,000 then the emergency fund should be between INR 90,000 to INR 180,000.
- Under special scenarios like having a sick family member or an expecting wife, one should have sufficient amount to handle the medical emergency plus an additional reserve.
- Further, one will need a bigger emergency fund if living in Mumbai then the person living in Nagpur with everything else same.
Ways to build emergency fund?
Emergency fund should be built over a period of time. Once you have decided on the size of emergency fund, put aside a small amount every month until you reach your target amount. This emergency fund should be saved following order of priority – first save it as cash in hand, second into cash in separate bank account, third into over-night or liquid funds and finally as bank fixed deposits.
Common ways to reduce your emergency fund requirements are –
- Have a credit card with large unused limits – This allows for immediate access to cash while giving you a month or more to pay your dues. I would suggest keep a separate credit card only for emergencies.
- Have a medical insurance for the entire family – Proper Health insurance with cashless settlements will take care of any large medical expenses and save you from financial stress.
Emergency happens suddenly at most unexpected moments. By having an emergency fund and properly using it can help one overcome the worst-case- scenario.
Hopefully this article will help you build better understanding of Emergency fund and its importance as part of risk management. Further, It will help you have a more detailed conversation with your financial planner or investment advisor. For more information please feel free to reach out to us via email at – firstname.lastname@example.org or by phone – 91-9515475381.
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