But how much emergency fund is needed?
Where can you invest this money?
Is there there a simple way to understand how to maintain it?
YES there is, and in this episode Anmol gives a simple 3 step approach to help you maintain your emergency fund!
Adding more to this... he answers the common questions you might have regarding emergency funds.
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Hi Guys. Welcome to "Money Ki Baat". This is your host, Anmol Gupta.
You must have heard me talking about maintaining Emergency fund. You can keep your Emergency fund in Savings Account or invest in Liquid Funds.
But, what is the exact formula?
How should you distribute the Emergency fund among Savings Account, Liquid Funds or Fixed Deposits?
In this episode, I'll give you a formula which you can use to maintain your Emergency fund.
In order to maintain an Emergency fund, I'll recommend you a 3 Step Approach.
Step 1 Determine your necessary expenses, i.e, you need to identify your expenses that cannot be avoided when you lose your job or fall into any other emergency situation. You cannot avoid your living expenses. Can you? Let's suppose, you pay 25,000/- as rent, and additional 25,000/- for food, groceries and other expenses like electricity and internet bills. These expenses that sum up to 50,000/- are unavoidable.
There can be further obligations beyond these expenses, like Loan EMI, or childrens' school fees.
Let's suppose, you have a taken a Loan and you're paying an EMI of 10,000/- and your kid's school fee is 10,000/- per month.
Hence, the sum of all your expenses that cannot be avoided is (50,000+10,000+10,000) 70,000/-.
Sum of your necessary expenses is 70,000/- for a month.
This means that if we want to maintain an emergency fund for a period of 6 months we need to accumulate 70,000 × 6, i.e, 4,20,000/-.
In case, if you lose a job or cannot earn money due to some other reason, then you'll have enough money to bear expenses for the next 6 months.
Step 2 Keep expenses of 2 months, i.e, 70,000 × 2 = 1,40,000/-, in Savings account. This is because, if you fall into any kind of emergency situation for which you need cash immediately, you can go to the ATM and withdraw money 24×7. If you invest all your money, then you will not be able to withdraw it whenever you want. Therefore, it is necessary to keep some amount in Savings Account.
Step 3 The remaining balance of 4 months, i.e, 70,000 × 4 = 2,80,000/- can be invested in Liquid Funds or Overnight Funds. This is because both the funds are safe and gives you more interest than a Savings Account.
I have spoken about Liquid Funds and Overnight Funds in details in my last episode. Please do check it out.
Summarising the 3 step approach,
Step 1 is determine your unavoidable expenses,
Step 2 park your expenses of 2 months in Savings Account
Step 3 invest your expenses of the remaining 4 months in Liquid Funds or Overnight Funds.
Now, I'll discuss some common questions related to this.
Q. If Liquid Funds are giving you more returns than Savings Account, then why don't you recommend to invest all the money in Liquid Funds?
This is because, it takes minimum one day to withdraw money from these funds. Hence, if you require cash immediately, you need to wait atleast for a day to withdraw money from these funds.
Q. Can we invest in Fixed Deposits instead of Liquid Funds?
Yes, you can park your money in Fixed Deposits instead of Liquid Funds. But I'll recommend you to open a Flexi Deposit account instead of a Fixed Deposit. If you have money above a certain limit in your Flexi Deposit account, bank has the provision of automatically transferring the excess amount to the Fixed Deposit account. Moreover, it is easier to withdraw money from Flexi Deposit account than Fixed Deposit. But before taking any such step you need to be well acquainted with the charges involved for premature withdrawal of Fixed Deposit or Flexi Deposit.
If the charges are insignificant, then you can open Fixed Deposit or Flexi Deposit account as well.
Q. Can we invest in Stocks or Equity Mutual Funds?
NO! Not at all. Stocks might give you the facility to withdraw money whenever you want, but it is very risky to invest in Stocks for short term. When you'll be in need of money, the stock market can be in any position, you can either make a profit or incur an excess loss.
The chances of losing money in Liquid funds are negligible. Although you'll get around 5-6% returns, your money will be safe.
Q. Currently, if we have no money for Emergency, should we only focus on accumulating Emergency fund and not invest in the market?
In this case, I would recommend you to keep a target of 1 year in which you have to build your Emergency Fund.
Hence, if you need 4,00,000/- for emergency fund for 1 year, then for the next 12 months, you need to invest 33,333/- per month for Emergency Fund.
If you're left with some surplus every month after investing for Emergency Fund, then you can start investing for other goals as well. If your situation is more complex and you are not able to figure out the way to build Emergency Fund from the scratch, then feel free to contact us to seek professional assistance.
One more important thing. Do not use the money which is parked in your Savings account for emergency purposes.
Just because you have money in your Savings account, you don't have to spend it. And if you cannot have a control on it, open a separate Savings account where you can park your Emergency Fund.
I hope guys, this was useful for you. You can follow this formula to maintain Emergency Fund.
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