The A to Z of an emergency fund

How much emergency fund should you have?

Traditional wisdom dictates that one should probably have about 6 months of expenses saved up in the event of an income loss. If you are self-employed/work in an industry where finding a job is harder then you should probably have more saved up.

 

Where to park your emergency fund?

As the name suggests, this is to tide over an emergency. It should be in extremely low-risk investments that will nearly guarantee your principal. FDs in Govt banks, Govt treasury bonds, Savings account are options you could evaluate. Do not get tempted by a higher return FD vs a lower return FD. Evaluate where there are almost zero risks to your principal and park your emergency fund there.

 

Liquidity

You would need the money fast and you shouldn't have to do distress sale to get that money. Evaluate options where you can quickly get the money into your bank account. Ask the bank manager or wherever you are parking your money as to how soon would this be credited. Some liquid funds may take up to 7-10 days for the amount to get credited.

 

Credit card is NOT an emergency fund

I have heard advice floating around that you can use your credit card as an emergency fund, please don't treat the credit limit on your card as an emergency fund. The annualized interest rate is about 30%-40%. In the off chance you have to default and pay the credit card bill over a couple of months, your credit score will take a beating. This might affect your chances at getting a home loan or may hamper your chances at getting a better interest rate for your home loan

 

Emergency fund protects your other investments

Think of this as insurance for your other investments. You can avoid distress sales to cover for the emergency. This would mean you can keep your other investments intact and growing well as they should.

 

How to replenish your emergency fund

When you can think clearly/calmly about the situation you are facing, decide how much money do you need to cover this expense. Pause your other investments like retirement planning etc temporarily to replenish your emergency fund. Once replenished you can resume your other investments. Don't worry about not investing for these few months. Life has thrown you a curveball, it takes time to pick yourself up and back on track.

 

What are your views on the topic? Drop-in your comments below


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