All of you may face emergencies in your life, the time when you need a large sum of money to meet unforeseen situations. The question is: Are you financially prepared to face such situations? In this article, we discuss why you need to set aside money to meet such situations. We also show you how you should create a fund for this purpose.
Emergency requirement arises due to two primary reasons. One, you or someone in your family becomes critically ill. And two, you lose your job. In the first case, your medical expenses will be unexpectedly high. In the second case, you end up with either low income or no income. Can you still meet your monthly expenses without taking money from your existing investments such as your child's education fund or your retirement account?
If your answer is yes, you already have an emergency fund in place! If your answer is no, allow us to explain why funding your emergency requirement is important.
You may argue that your employer provides you a medical insurance. You may also have a personal medical insurance top-up plan, which covers your medical expenses above the limit that your employer covers. We still urge you to set aside money towards medical emergencies. Why? For one, if your employer faces severe business downturn, consequent cost-cutting measures could lead to lowering your medical coverage. For another, if you lose your job, you will not have a medical cover, till you find another employer!
Consider the possibility of losing your job. You may argue that your job is “sticky”. But in the world of globalisation where companies are continually searching for high returns, you have to realise that all of us are exposed to the risk of losing our jobs. You have to be prepared should the unfortunate event happen!
You should set aside a multiple of your monthly expenditure as emergency fund. You have to include your home loan and other loans when you calculate your monthly expenses. In the event you lose your job, you can manage your household and loan obligations while you search for another job.
The amount that you set aside as the emergency fund increases with age! Why? For one, medical costs increase with age. For another, as you age, the chances of getting another job reduce, should you lose your current job. You would do well to set aside at least three times your monthly expenditure if you are between 25 and 40 years. If you are above 40 years and working, you should keep at least 6 times your monthly expenses.
For those of you who are retirees, we recommend 12 times your monthly expenses! Why? While you do not have to worry about job loss, your primary concern should be your investment besides medical costs. What if, as a retiree, you depend on your investment income to maintain your lifestyle and the market declines 25 per cent? You will be forced to sell your loss-making investments to finance your monthly expenses. This would create problems because continual selling of loss-making investments will deplete your portfolio, leaving you with no money for consumption in later years! Your emergency funds will act as cash reserve to maintain your lifestyle during such market downturns.
You should keep your emergency fund in a separate savings account. The objective is to safeguard your capital against any decline in value due to market risk. Further, you should be able to withdraw your money easily. If you are quite keen on earning higher returns, we half-heartedly suggest that you keep 50 per cent of the emergency funds in savings account and the rest in short-term bank fixed deposits. Emergency fund forms part of protection assets in our Wealth Mapping framework.
(The author is the founder of Navera Consulting, a firm that offers wealth-mapping and investorlearning solutions. He can be reached at email@example.com)