How much emergency fund should you have?

While, income levels have reason more or less consistently over last few decades almost everywhere in the world, so has the propensity to spend. Thanks to rise of consumerism, a lot of people, even seemingly well-to-do ones are living paycheck to paycheck.  Or even worse, lot of people are in (mostly unnecessary) debt. Come some emergency, most of them would be left scrambling for funds. This brings me to an often asked question on personal finance – How much emergency fund should you have?

Before coming to that, let us try to understand the purpose of emergency fund and where all it may come handy.

How much emergency fund should you have?

Typically, emergency fund comes into play during one of the following scenarios:

  1. Loss of income – It can be a job loss, or inability of company to pay salaries (e.g. Jet Airways in recent times) which may eventually culminate into job loss. If you are a freelancer/ have business few bad days/ months can lead to similar situation. This eventually impacts your cash inflows. And before long, you are short of funds to manage day to day expenses.
  2. Medical emergency – Arguably, this is the single most important reason why you need to have an emergency fund. Health emergencies can strike anyone, anytime. Even if you are well insured, you may need some money upfront to deal with it. Insurance may or may not be able to help you immediately. Having no money at disposal would be one of the last things you would want at that point of time. 
  3. Any other unexpected expense – Unexpected situations can arrive anytime. For example – your laptop crashes and you need to buy a new one, or you lose your phone and need a replacement, or there are sudden repairs needed in your car, or you need to travel urgently to visit an ailing relative.  In most of these cases you may not have luxury of time before the need to spend money.

There are few other things, which some people can consider as an “emergency” – but you may not – for example, need for carrying out repairs in home or paying school/ college fees of your kid(s) which you haven’t budgeted for. However, most of these can be budgeted for and should be anticipated (in an ideal world!) rather than being treated as an emergency.

This brings us to the main question at hand – How much emergency fund should you have?

(Read – Expenses that can set your financial plans back)

Here are some factors you should consider while creating an emergency fund. 

  • Your current expenses – You will want to continue same standard of living in case of job loss & manage you expenses (including EMIs, if any).
  • Dependents – If you don’t have any dependents you’ll need less money. If you have more dependents & have a family to take care of, your requirements are likely to be much higher.
  • Health risk in case of dependents – Not an emotionally pleasing thought, but if someone in your family is prone to a major health risk, you need to have larger emergency fund accessible to you.
  • Accessibility of funds – While this may not impact the “number”, it may have impact upon the accounts/ assets you have your money in. For instance, your money in “real estate” won’t be accessible immediately. Nor will your money in tax saving accounts like PPF (partial/ premature withdrawal may be permissible in some cases). 

There is no set answers to how much emergency fund you should have. Most of the people recommend at least 3 months of emergency funds. Some recommend 6 or even 1 year of emergency fund. Like most of the things in personal finance, the answer to this is more personal than financial. 

My take on how much money you should have in emergency fund

3 month worth of expenses in emergency fund may be OK if you have no dependents. However, if you have dependents. you should have at least 6 months of emergency fund ready. (And up to 1 year of emergency fund accessible to you at a short notice). This money couple help you tide over times like job loss or medical emergency or any other unexpected emergency, at least for some time. 

Your emergency fund should ideally be in a mix of – bank savings account, fixed deposits or liquid funds. You can sell your equities/ mutual funds also if need be, but the money you get may be dependent upon market situation at that point of time. At the same time, having a credit card can be very handy in case of emergency. Though, don’t allow the balance to accrue & pay off your bills on time!

Creating an emergency fund may take some time, especially if you have just started working. While both are important, you should first have an emergency fund in place and then invest in your long term financial goals. Remember, the objective of this fund is to be helpful in case of need – not to get best possible returns. 

In case you happen to use a chunk of your emergency fund (for real emergency, not for regular expenses), re-build that emergency fund. 

So if your monthly expenses are Rs. 100,000, you should have an emergency fund of at least Rs. 600,000 and probably an equivalent amount accessible to you when need be. If your expenses are $5000 a month, you should have an emergency fund of at least $30,000 and an equivalent amount accessible to you. (Assuming you have dependents). The number can vary according to your personal situation. And get adequately insured too.

What if you don’t have emergency fund?

In this case you may be forced to take debt. This can be in form of personal loans, or default on credit cards or borrow from friends/ family (who may/ may not charge interest). You may also be forced to take any work that comes your way (especially in case of job loss). This may have negative impact on your career. At the same time, you can be subject to higher levels of stress, due to financial issues.

Of course, none of these come into play if you don’t face any emergency! And you can give a good shot of mitigating the impact of unforeseen emergencies – if you have an emergency fund in place. 

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