Emergency fund

Your financial plan needs to be built on the solid pillars of safety and security. While institutionalised insurance counters the risk to life and property, it’s wise to have your own personal insurance too – your emergency fund. It’s a reserve amount to help you tide over a crisis. While setting it up, remember to:
  • Invest in liquid avenues such as savings accounts or money market mutual funds, which can be encashed within 24 hours. For an emergency fund liquidity is important, not high returns.
  • Have a separate account and not club it with your regular savings account.
  • Let your spouse/ family member know about it.
  • Create it in joint names, such that any one of the joint holders can operate it.

An emergency fund is sacred. Do not tap into it unless there’s an actual emergency in your family. The cumulative effect of interest being added back and compounded will help the fund keep pace with inflation.

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What’s the ideal amount for an emergency fund?

There’s no standard answer, but a common sense approach suggests setting aside at least 12 months of your family’s living expenses. For instance, if your family’s normal monthly living expense is Rs 50,000, the emergency fund should approximately be 50,000×12 = Rs 6,00,000.

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Flexi deposits in banks are well suited for emergency funding.

In a flexi deposit, a small portion is treated as balance in the savings account, and the rest as fixed deposit. For instance, in a flexi deposit of Rs 1,00,000, only Rs 10,000 could be the amount in your savings account. The remaining Rs 90,000 would be fixed deposit, earning a higher rate of interest than what the SB account offers.

Liquidity is easy. Even if you write out a cheque for Rs 50,000, you will only redeem the fixed deposit portion prematurely. Of the remaining amount, now Rs 5,000 would be in your savings account and Rs 45,000 as fixed deposit.