Financial Security: 7 Reasons Why Having an Emergency Budget is a Luxury.
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In this article , we will understand Why Having an Emergency Budget is a Luxury.
Is having an emergency fund a luxury?
As per a Business Standard article, 75% of Indians don’t have emergency funds. As per a 2022 Bankrate survey in the US, only 44% of Americans could cover a US$1,000 emergency from their savings. In most cases, as per the surveys, people treat their close ones, such as parents, relatives, and friends, as emergency funds.
However, should we bank on our closed ones to pay our rent, EMIs, medical expenses, and groceries for months? What if our close ones are unable to fund us for months?
People don’t keep emergency funds (EF) because they earn well and have health insurance from employers, and some say they are already saving some for retirement in the form of PPF or mutual funds, etc.
But are these reasons enough not to keep an emergency fund? What if there is a sudden covid like scenario, or in general, job loss, major house or car repair, temporary disability, some severe illness, or, in extreme cases, death in the family? Emergencies catch you off guard and can’t be predicted in advance, but we can prepare for them. Furthermore, emergencies are not selective; they can happen to anyone. The idea is to explore it from all angles and decide if EF is a luxury or a need.
What is the need for an emergency fund?
Life is unpredictable, and we never know what will hit us next. COVID was a classic example when many suffered job losses, even those of sole bread earners, and mounting medical expenses. To keep going and pursue our financial goals, we should be equipped to handle financial exigencies, loss of income, and unavoidable expenses.
Some everyday situations where we all would need emergency funds if there are job loss, medical emergencies, sudden tax liability, car or house repairs, accidents, etc.
We can’t keep digging into our long-term investments for emergencies and always take expensive personal loans. But however, we all must have a corpus that will let us sail through the turbulent waters of emergencies.
Related Article: Learn 8 ways to Grow your Finances if You aren’t Saving Enough.
What should the emergency fund cover, and how big should it be?
Emergency funds should be big enough to cover daily household expenses, school fees, house and other EMI’s, insurance premiums, etc. for a minimum of six months. One should jack up EM if one has pets, kids, several vehicles, an old house needing repair, etc. We should consider all those expenses, which are unavoidable. While calculating emergency funds, one should never forget insurance premiums (life, health, accident, etc.), as that will further deepen the crisis if there is a medical emergency and if we neither have funds nor an active insurance policy.
Therefore, once we include the above expenses, our EF should cover a minimum of six months and ideally up to 12 months of expenses. If someone has a monthly cost of, say, one lakh, then 12 months of expenses would be 12 lakhs, which is not a tiny amount and can’t be set aside easily. Therefore, one can slowly accumulate some amount every month from their savings till it reaches the desired corpus. One should start investing only after the desired EF has been secured.
In cases of multiple income streams or both husband and wife earnings, emergency funds can be lower than 6 months. For people who have a stable business, emergency funds can be lower; however, for someone who has ventured into a start-up and doesn’t generate stable cashflows, emergency funds should be on the higher side. In the case of housing loans, etc., one should have it covered well for at least 12 months of EMIs in the emergency funds.
Where should I park or invest the emergency Fund?
Accumulating the emergency funds amount is one thing, but keeping it safe and liquid is another. Although emergency funds should be parked in a safe instrument, the return should not be too low, i.e., much below inflation.
Furthermore, one should be able to liquidate it quickly. Another important aspect is to keep EF in a separate dedicated account instead of in your regular savings account, as there will be a tendency to use it.
One of the effective ways of accumulating emergency funds is to set automated instructions in the form of RD, FD, etc., which can be set in sweep-in mode. SIPs in liquid funds can be another good option, as they are relatively safe and offer quick liquidity.
If the emergency funds is on the higher side for say 12 or more months of expense, one can even invest partly in gold ETFs. However, one should avoid investing in risky assets such as stocks, equity mutual funds, or cryptos.
Advantages of Emergency Funds:
There are several advantages to keeping an emergency fund, including the following:
1. Flexibility in Treatment Choices
In case of a sudden health emergency, emergency funds provides an added layer of security in opting for the treatment of our choice. Medical insurance is a big saviour in such situations, but in some cases, cashless claims may be rejected, and some of the treatments may not be covered under the insurance. If we have EF, we don’t have to worry at that point about choosing the best treatment or arranging funds.
2. Financial Peace of Mind
In most emergency situations, readily available funds provide immense relief, and we can handle the situation well.
3. Quick Access to Funds
If we park the emergency funds in the right instruments, we can get the funds instantly or within a maximum of 24 hours. Time is of the essence in an emergency.
4. Prevents Debt Accumulation
In dire situations, people are forced to take expensive personal loans, and emergencies don’t come just once, so debt can accumulate.
5. Protect Your Financial Goals & Proactive Financial Planning
Emergency funds enable us to proactively plan our finances and keep pursuing our long-term goals without risking, aborting, or stopping monthly contributions.
6. Helps To Cope up with Loss of Income
In case of a loss of income, if we don’t have emergency funds, we tend to dip into our savings and investments. If we have started our career, we may not even have much savings, which creates a stressful situation, leading us to take expensive loans.
7. Leads to Independence and Self-Reliance
EF also provides us with self-respect and makes us self-reliant in even critical financial situations. We don’t have to knock on doors for financial help or go to the bank for a loan.
Final Thoughts
Emergencies can take a physical, emotional, and mental toll and are detrimental to our wellbeing. Furthermore, if the emergency follows a financial crunch, then the agony is unbearable. EF provides a cushion in an emergency; however, we should be diligent on when to use it. EF should be used only when we have no option left and only for select causes; it can’t be used for luxury purchases such as a TV or phone or modifying our car.
If you need to use some amount from emergency funds, you should replenish it as soon as possible. Emergency funds should also be sufficient and parked in a safe and liquid instrument. In this fast-changing and unpredictable world, emergency funds are not at all a luxury but a necessity for each of us. This will enable us to sail through turbulent times smoothly.
Lastly, emergency funds shouldn’t be treated as a replacement for insurance. In addition to life and health insurance, one should also have accident insurance, which includes disability and critical illness insurance. If you never gave a thought to emergency funds, 2024 is the year you should have it in place.
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