If you know the importance of having an emergency fund but are wondering how to get started, list your regular monthly expenses. The quantum of your emergency reserve should be determined based on the regular monthly unavoidable expenses to run your home, certain lifestyle expenses, financial obligations, liquid assets, and other liabilities.
You can estimate the amount you need to maintain in your emergency fund if you lose your job, confront a medical emergency, or face other unexpected expenses. A Fixed Deposit is a risk-free and safe investment option, free from market fluctuations. It is a banking product that has been trusted for years and continues to make a place in millennials’ investment portfolios.
Emergency fund rule
Broadly, the rule applicable to building an emergency fund for yourself is Contingency Reserve = 12 or 24 months of regular monthly unavoidable expenses, including EMIs. Suppose your regular monthly unavoidable expenses, including EMIs, are Rs. 60,000. The minimum amount you should hold as contingency reserve should be Rs. 7.20 lakh, with an upper cap of Rs. 14.40 lakh.
You may add 10% extra for medical emergencies, taking into account your family members’ Health Insurance and medical history. Ensure you have bought the right Life and Health Insurance coverage to hope for the best and be prepared for the worst.
Avenues to park the emergency funds
- Savings Bank Account: A small portion of your contingency reserve can lie in a separate Savings Bank Account while earning interest at the rate of 3.5% to 6% per annum, as opposed to lying idle at home. By depositing your money in Bank Accounts, you can ensure easy access to it during an emergency and make online payments through the Internet and Mobile Banking portals.
- Term or Fixed Deposits: Most people wonder what a Fixed Deposit is and how it works. It is a financial product which banks offer that allows you to earn higher interest income than Savings Accounts while offering monthly, quarterly, or half-yearly payouts.
If you aim to counter inflation by earning a slightly better interest rate, some of your emergency needs can be parked in a Fixed Deposit, which offers fixed and secured returns, meets liquidity needs, and can be linked to financial goals. You can apply for a Loan against the FD Account rather than prematurely withdrawing it.
- Debt and Money Market Mutual Funds: Debt Mutual Funds are known to invest in fixed-income securities like Government Securities, Corporate Debentures, Bonds, and Money Market Instruments. They are ideal for investing funds you may want to access at a short notice. They are less volatile than Equity Funds. However, they also carry credit risk, liquidity risk, interest rate risk, price risk, macroeconomic risk, and so on.
If you want to park a small portion of funds for your emergency needs, consider investing in Overnight, Liquid, Ultra-Short Duration, Low-Duration, and Money Market Funds.
