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Financial Planning 7: Emergency Fund planning.

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Emergency Fund planning.

One of the Key area that’s missed by many is emergency Fund planning. We have found that 90% of those who plan finances do not have this vital component.

An emergency would mean that the event was not expected and it required immediate attention resulting in flow of money outward.

Your rainy day fund:

A financial plan for Emergencies is required because emergencies can happen to anyone any time. It could take the form of accidents or health issues or repairs and maintenance or any sudden expenses that was not included in your budget allocation. Normally, most of us would rely on credit facilities like credit cards or bank loan or just pay cash from your savings account by breaking any other monthly commitment to meet these expenses. This is where we lose our control of our already set investment plans and budgets. Hence, planning for emergencies is a very important step in financial planning.

See it coming:

Some of the probable emergencies can be spotted if you look around – for example those who have aging parents dependant on them  or a car that’s more than 5 years old  or a home that’s due for painting and maintenance must expect that some amount would be required in the near future  for meeting the probable expenses.

Job loss , break up in marriage , legal tussles , business failures and health issues may be much more difficult to predict  but with some intelligent working , we can see it coming – it’s not impossible to predict many of these emergency situations.

Emergencies due to natural disasters or acts of God may not be in the immediate vicinity of our expectations. But in this case, those who have adequate insurance cover can face the situation better.

Tomorrow breakers:

If you do not have an emergency fund, you may have to borrow from friends and relatives or rely on various types of bank loans and pay it back with interest. If the requirement is much more than what you can manage with loans, you may even have to pledge your assets like gold and property. Still if it doesn’t work then the only option is to dispose off some assets or liquidate the investments you have. In any case your entire financial plan is disturbed and may need to be reworked resulting in huge loss. In short , if you are not prepared to meet the emergency needs , it will threaten your long term and short term financial plans.

 How to start accumulating funds?

Automation is the best way to accumulate systematically. There is no better way to create commitments than automating it from your accounts so that whatever is the situation, a fixed amount would be taken away and you live only with the rest. Emergency funds can also be created by setting aside bonus or tax refunds or such one-time income you get. Such windfall gains are normally spent recklessly by people. So it’s all about being determined to create this fund.

How much fund do you require?

There is no definite answer or formula to accurately estimate this. The answer to this question depends on each individual’s life situation. Hence as a thumb rule, it would be advisable to maintain a fund equalling to 6 months household expenses.

Where to park these funds?

The requirement for emergency funds may rise anytime. So the thumb rule is to keep these funds parked in liquid assets (aka assets which can be converted into cash quickly). Short term fixed deposits and sweep in deposits are examples. These funds can also be parked in high security mutual funds which invest less in equities and more in bonds and deposits. The main factors to look for while parking emergency funds would be:

  • Low risk
  • High liquidity
  • Decent returns and
  • Accessibility

Any investment that meets all the above criteria can be utilised to form emergency funds.  The sooner you prepare an emergency fund; the better off you’d be in your finances.

 

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