Emergency fund – savings for that rainy day!

The one thing we can all be sure about life is to expect the unexpected. And the best you can do is be prepared for those unexpected emergencies. Continuing my last article, let us talk about financial emergencies.

How does a financial emergency arise?

Financial emergencies can come in the form of a job loss, significant medical expenses, home or auto repairs or something you’ve never dreamed of. The last thing you want to do is be forced to rely on credit cards or a loan which could simply compound the problem.

How to protect ourselves from such emergencies?

The answer is simple. Create an emergency fund.

What is an emergency fund?

In simple words, emergency fund is the amount set aside to meet all your financial requirements during emergencies.

Where is your current status of emergency fund?

As far as my experience goes, most of you working people are not setting aside money in a systematic manner. Hence, most of your salaries would be lying idle in your savings account or fixed deposits at the max. This means you’ve already created your emergency fund. Congratulations!

How much is enough?

The rule of thumb is to park your 3-6 months of your salary. And if the number of dependents are more, park more than 6 months of your salary according to your requirements.

Where should you park the money?

Emergency funds should be easily accessible and be easy to withdraw. Hence, it should be maintained in cash or cash equivalent form which could be in the form of Fixed deposits or in a liquid fund account in mutual funds. Savings account is not advisable since the amount of interest rate is low.

How to create?

Once you have decided on the amount, do not try and save everything in one month. Do it gradually. Start saving monthly. You could park it in savings account or in a recurring deposit to meet your required emergency fund. Recurring deposit is advisable for greater returns.

Final words

The best way to maintain a healthy emergency fund is not to touch it until you have an emergency. Don't withdraw cash from your emergency account to fund your unnecessary expenses or for buying something which you like. Never allow your instant gratification instincts to play a part in withdrawing from your emergency fund you accumulated over the years. If you have any major expense, see if you can postpone it to the next month rather than funding it with your money set aside for emergencies.

Further, Monitor your budget periodically and make sure that your emergency fund is always at the optimal levels. Whenever there is a change in your financial situation, make sure you revisit your emergency fund requirements and make the required changes. This helps in maintaining a healthy fund to counter unnecessary debts during emergencies.

Feel free to ask any questions. I would be glad to answer. Cheers!

Six steps to financial planning

In this post, I am going to list down the steps all of you must take to secure your finances no matter how much you earn. It won't be elaborate. Very precise and to the point. Following are the few steps you should take -

1. Find out where does all your monthly income go?

Make weekly expense charts under different heads such as conveyance, entertainment, food, rent etc. Track your expenses for at least three months and see the pattern of your expenses.

Here, do not worry. You only need to track your cash outflows and not get rid of them. But one thing you must do is segregate your necessary vs. unnecessary expenses and calculate how much you can save each month and in the next 12 months.

2. Assess your current financial situation. Create a list of your assets and liabilities. This will help you in your financial planning and goal creation.

3. Now that we have identified the cash inflows and outflows, ask yourself the following questions -

a. Have you set aside an emergency fund?

b. Do you have adequate health insurance?
c. Do you have adequate life insurance?
d. Have you planned for your retirement? (you might wonder who plans for retirement in 20's right? Trust me, start saving early, compounding does wonders in the long run. There is a reason why it is called the eighth wonder of the world)
e. Have you planned for your other goals in life? For example - your wedding, your car, your children's education, your first home etc.)

4.The  important question is how much is enough. I will write detailed posts on each of the above. However, for you to begin with -

a. Emergency fund - six months of your salary
b. Health insurance - this would depend on various factors. Depends on your ability to pay premium, your medical expenses in the past, medical conditions, age etc.
c. Life insurance - generally 10 to 12 times of your annual earnings. Remember, when we talk about insurance, its strictly term insurance and not any other form of insurance.
d. Retirement and other savings - This would depend on your goals. set those goals, there are plenty of calculators available online to help you. But please remember to set achievable goals. How can you achieve these goals? There are plenty of routes depending on your tenure. Direct equity and Mutual funds for long term, mix of equity and debt for medium term and debt for short term.

5. This is the most important step. This is the time to execute and implement. The steps listed above are basic minimum steps towards financial freedom. Don't be lazy and start working towards it.

6. Monitor your goals. This step must be performed annually and hence would come much later.

Read this post for more than one time. Understand the requirements. You may also do a Google search for the importance of each item in the financial planning process.

My following posts would be why we need all the above, how to proceed and where to go. Each one of them would be discussed individually.

Feel free to give suggestions / improvements.

Cheers!