Coronavirus reminds – Emergencies don’t wait for Emergency Fund

Maybe I shouldn’t use the Coronavirus pandemic to give any advice. It doesn’t feel right, to be honest.

But what to do – when things are normal and routine, people don’t listen. It’s only when things get out of hand that many realize that they are living on the edges and how easily they can be punched in the face without a warning.

What Warren Buffett said about something else is quite applicable here – “It’s only when the tide goes out that you discover who’s been swimming naked.”

I am talking about Emergency Funds in this post.

But to be realistic, this is not the time to create an Emergency Fund if you haven’t had it till now. It is one of those rare times when such funds are/will be used. And if you don’t have it, I am sure you would be worried about it now.

We are living in unusual times. What’s happening around us is unprecedented. Unimaginable city lock-downs (or rather country lockdowns), people being quarantined, sealed international borders and what not. If only 2-3 months back someone had told me that all this would be happening, I would have shrugged it off as a joke.

But it was not meant to be. So here we are and here it is.

And when health is a higher priority for all of us, then talking about personal finances doesn’t seem logical. But these are the times that highlight and test how well we are prepared to handle unexpected events.

We can never be 100% prepared. But even if you are prepared to handle 80-85% things that life throws at you, then you are doing really good.

So what risks has this situation created apart from the obvious health risks?

Possible interruptions in income. Employers have been asked to not cut wages. But we still don’t know how long this thing would last. And job cuts in a few sectors cannot be ruled out. Then changes in expense patterns in the near term are quite obvious. The government has today only offered banks the option of giving 3 months moratorium for loan EMIs to borrowers.

All these and possibly many other factors underline that an emergency fund should be the starting point of any good financial planning exercise.

It’s a non-negotiable for most people.

As the name suggests, an Emergency Fund is a pool of money that is set aside for only for emergencies and for unexpected, unplanned events. It’s a buffer for exigencies which ensures that your regular life isn’t disrupted (beyond a point) if there are any temporary disruptions in personal cashflows. And it helps cover your basic fixed costs for a certain period of time.

How big should your Emergency Fund be?

There are thumb rules that people follow – like having 3-6 months worth of expenses. And that’s a good start. But this is good enough for everyone?

I think the minimum is 6 months that you should have.

For those who work in sectors with a higher probability of job loss or if they have more responsibilities or if they are the sole earners of their family or are self-employed, it should be higher. Something between 6 to 12 months worth of expenses.

Let me just briefly touch upon which expenses to consider in such calculations:

• Start with the important ones like rent (and/or home loan EMI), food, non-food consumables, groceries, utilities, school fee, transportation (fuel) costs, healthcare expenses, other loan EMIs, salaries for support staff (if any). You may also want to include important yearly expenses like insurances, buffer for repair and maintenance, etc., too.
• Other non-critical but regular expenses on entertainment, eating out, vacations, etc. aren’t exactly the categories you spend money on during emergencies. So those can be left out for starters as the idea is to focus only on basic, unavoidable and essential expenses.

And if you haven’t realized by now then let me highlight it. Your living expenses are very different from what your colleagues or friends have. So just because he keeps aside Rs 3 lac for emergencies doesn’t mean that the same amount is best for you. You need to figure out what’s right for your situation.

But ofcourse emergency fund should be in place before emergency strikes. No point planning for it after something has happened. And that is what the title of the post also highlights. Emergencies don’t wait for your Emergency Funds. They just come randomly.

Many feel that they can use their credit cards in times of need.

And rightly so. Given the ease of use, you can definitely use credit cards. But credit card interest-free period is just about a month and half long to the max. After that, you have to repay. Right? So sooner or later, you will have to find funds to repay the credit card bills. Because if you don’t pay credit card bills in full, then you need to pay a 30-40% rate of interest.

(Do read how credit card interest calculated and Why you shouldn’t just pay Minimum Amount Due on credit cards).

Another factor is that you can use your credit cards in emergencies only if you haven’t fully utilized it even beforehand. So you shouldn’t just depend on it if you have a credit card fueled spending habit.

Where to keep your Emergency Fund?

This is plain and simple.

Before deciding, do understand that when it comes to Emergency Fund, returns or tax benefits don’t matter at all. The primary feature of an emergency fund should be its liquidity, i.e. your ability to access it quickly. And that is what you should be looking for when parking your emergency funds.

So what to do? Few points:

• For those who are conservative (or don’t require a very-large Emergency Fund), its best to stick with simple fixed deposits. Or put a small part in the savings account and opt for Flexi-FDs which give similar liquidity to a savings account but better FD-like returns.
• For others who are slightly less conservative (or wish to park bigger amounts), they can use a combination of fixed deposits and debt funds (liquid funds and/or ultra-short duration debt funds).
• When making FDs, best to stick with the top banks (the largest ones like SBI, ICICI, HDFC, etc.). Don’t be baited by higher returns given by smaller ones. You don’t want to worry about banks going poof right?
• Also, when making FDs, don’t make one large FD. Break it into small sizes. So that you don’t have to break the full one large FD when you require just a small amount for an emergency.
• You will find tons of articles about how to create an emergency fund using mutual funds. These are good suggestions. But remember, if you have doubts, then just stick with bank FDs. Plain and simple.

That’s about it.

But there is one important aspect left. Many feel that they don’t need a separate emergency fund when they already have a bigger investment portfolio.

Ideally, you should not dip into your long-term investments for emergencies. Because it’s possible that your emergency may come immediately after a big market crash, then if you withdraw from your investments, you will have to big large losses. And then that would be painful. But if you do not have a standalone emergency fund (which is your mistake by the way), then you have no choice but to dip into your long term investments.

And on the other end of the spectrum is the mistake of using the Emergency fund for meeting your planned financial goals. No, don’t do that. It’s a mistake.

The emergency fund is only for emergencies. It’s not a buffer for regular expenses. And please don’t get tempted to use Emergency Fund to invest in market falls. I know you might be tempted to. But don’t do it unless you are an adventurous cowboy who wants to take the double risk of seeing the markets fall further and ending up with zero emergency savings. Imagine if the emergency strikes just after you use your emergency fund to invest. Not a good scenario right?

So all said and done, the fact is that When a financial emergency strikes, you will be in a bad spot in the absence of an emergency fund. And you wouldn’t want to be there.

And Never wait for an Emergency to create an Emergency Fund.

With the virus thing going around, now is not the time to create the fund. But remember this for the future.