If you have already studied the blog talking about the steps you must take before investing, read directly from here.
Hope for the best. Prepare for the worst. Start your Emergency Fund before you make any other investment.
You start investing. You feel good when you see your net-worth grow to a couple of lakhs in some time.
Shit happens. For example, one can lose their job. Likewise, their spouse can lose their job. One’s sibling might need money. Similarly, you might want to send your parents on a trip. A legal liability can come up. One of hundreds of unpredictable things can happen. The corpus goes to zero.
Not a problem, you say. You will start again. But in the process, not only do you lose money directly, you lose out on The Power of Compounding.
For example, if we take a random amount for calculation,
the 2 lakh you had to let go at the age of 30, which you had accumulated after investing for a few years, would have become over Rs.20,00,000/- at the time of your retirement at 60, in a humble FD @ 8%! In 20 years instead of 30, it wouldn’t even have become 10 lakh!
|Amount invested||At Age||Amount you get at 60 years of age|
at 8% Compound Interest
And we are not even getting into high-return instruments right now. Now if you think you can afford this kind of loss, fantastic. Otherwise, do not skip this step.
So, when you skip setting up an emergency fund, you are not losing just the amount 2 lakh, you are losing a few years of compounding. In the long run, this is a much bigger loss when it comes to growing your money. You can always earn more money to replenish your emergency fund. Unfortunately, us mortals cannot generate more time.
Another reason you need a dedicated emergency fund apart from your investments is that most investments, including FDs and Mutual Funds have exit loads if withdrawn before a certain period.
Avoid losses of time, it is your most valuable asset even when it comes to investing and compounding, and start create an emergency fund today.
Where do you keep your emergency fund?
- Credit cards have, to an extent, reduced the need to keep an emergency fund. But don’t rely on them entirely. You don’t know when an emergency might strike. At that time, you might have expired your credit limit.
More importantly, using money at high interest isn’t something you would relish at the time of a financial crunch.
- Short term RDs are probably the only bank instrument I would ever recommend, and that too only for this particular purpose. Recurring Deposits are good for creating your emergency fund as their lock-in makes sure that you don’t withdraw prematurely. To clarify, use it only to develop your emergency fund by investing a little amount every month. Consequently, once your corpus is developed, you should ideally move it to a Debt Mutual Fund.
- Debt Mutual Funds are the ultimate answer to where you should keep your emergency fund, You essentially give secured loans to companies or governments and earn interest.
How much should you have in this fund?
Well, opinions differ. Think of it this way. If one goes income-less for 3 months, they will need an amount worth 3 salaries to meet their expenses during that period. Likewise, if they go income-less for 6 months, they will need more.
The amount depends on each individual’s situation. For instance, someone who lives in a rented house will need more, someone who can bank on their parents for emergency money will need less.
Certainly, having a cashless medical cover will reduce the amount needed drastically
(Read why you need a medical cover, and what to look for while deciding one).
I suggest keeping a 6-12 month fund, which should be enough to cover any and all unfortunate situations.
If you want to start with a Recurring Deposit, the best way to start would be to look for banks with the highest interest rates, on Google.
To see how much you need to invest every month in your Recurring Deposit to reach your target Emergency Fund, use this Excel Sheet:
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