Netflix and Finance? Why not! Season 1 Episode 1 is here. All you need to know about Emergency Funds
I have been guilty of binge watching Friends (yet again) during this quarantine. In these uncertain times, something familiar really helps. While I was binge watching the episodes, I said to myself -
Hey, why not learn a thing or two about FINANCE from these TV shows? BAM! I decided to jump right into this idea and start this series. If you observe carefully, these TV shows are not only entertaining, but also super informative.
I hope y'all are as excited about this series as I am.
In this week's newsletter, I will be discussing about the most important part of personal finance planning - EMERGENCY FUND. But hey, like always, let's make this fun and interesting.
I'm sure all of you have watched the most epic, legendary TV show - F.R.I.E.N.D.S.
Let me take you through a few specific episodes. Remember, "The One with Five Steaks and an Eggplant", Season 2 Episode 5, when Monica suddenly loses her job? She is accused of accepting "gifts" aka "bride" from a meat supplier. Monica's dad Jack Gellar, had advised their children to always save 10% of their paycheck. Dip into your savings, that's what it's there for, he said. Did Monica follow tis rule? NO. Was she financially prepared for this sort of emergency? Well..
In Season 5, Episode 9, "The One with Ross's sandwich", Ross is put on a sabbatical to take care of his mental health / anger management issues. Sabbaticals are usually unpaid, and this could happen to anyone.
In Season 9, Episode 10, "The One with Christmas in Tulsa", Chandler suddenly decides to QUIT his high paying job, without a backup job. He wanted to find a job he really loves and just wanted to be back from Tulsa.
ALL these episodes lead to one common topic of discussion - ALWAYS BE PREPARED FOR THE UNEXPECTED. This could be in any form and differs from one individual to the other, as illustrated above. Had Monica planned for an emergency fund, things could have been a lot more different for her.
Now, what is an emergency fund?
“An emergency fund is a corpus fund set aside to meet unexpected / unplanned situations. Basically, this is a fall back cushion for unexpected expenses.”
This pandemic is yet another case of sudden unemployment, pay cuts, job losses, factory shutdowns, lockdowns, besides the virus.
How much money should your Emergency Fund have?
“Most experts recommend saving up to 6 months of living expenses"
This totally depends on the assessment of your financial situation. If you are the sole earner of the family, then you'd probably want to save a little more. Living expenses could mean all your fixed expenses (Rent, Mortgage payment, Insurance premium) and few variable expenses (Grocery, Electricity, Internet bill, Phone bills etc). Basically anything that you consider essential.
How can you start building your Emergency Fund?
Pay your self first, before you pay others.
For those who have been working from home during this pandemic, review all your expenses. You will observe that you have been spending a lot lesser now. (Think of maid expenses, salons, gym, fuel, eating out etc to name a few). These savings can be added to your emergency fund.
For others, again a review of your expenses can help you understand where you can cut back. You can start with a small percentage but make sure you do this consistently on a monthly basis. The goal is to START.
Where should you invest this money?
Emergency funds should always have high liquidity. This means that the money should be readily available at short notice, i.e. in case of an emergency.
The ground rule is that this fund should not otherwise be accessible, other than in case of an emergency. If you use up the funds for an emergency, always replenish the fund. When you are secure with an emergency fund, you can then look out to invest the rest of your money.
The objective of an emergency fund is about liquidity. Interest rates, taxability etc may not necessarily be the primary factors while considering the investing options. Let's look at some of the options that you might want to explore:
a) Savings Bank Account
Although this option offers high liquidity, decent interest on savings, and has no risk, you might want to explore other options too before you finalize on this one. If you opt to save the emergency money in your bank account, make sure you park the money in a bank account other than the one that you use on a day to day basis. You can keep a portion of your savings in your bank account and the remaining portion can be invested in the options listed below.
b) Flexible Fixed Deposits
The interest rates for Flexi-fixed deposits are usually higher than interest rate on savings account. Since the usual fixed deposits do not offer liquidity, Flexible Fixed Deposits could be your go-to option. This combines the features of savings account and fixed deposits. You can read more about this scheme here - https://www.icicibank.com/blogs/fixed-deposits/knowing-the-benefits-of-investing-in-flexi-fixed-deposit.page
c) Debt Mutual Funds
To give you a gist, Debt Mutual Funds are relatively liquid and quite safe. They carry "low risk". Debt Mutual Funds invest in fixed income securities like government securities, treasury bills, corporate bonds etc.
In simple words, a company "issues" a debt instrument when it wants to raise funds. So in a way you are lending money to a company and in turn earning interest.
Although there are various types of debt funds, you must always remember the golden rule of "high liquidity". Liquid funds is the most popular choice here.
Liquid funds invest in debt instruments with a maturity period of not more than 91 days. This means these funds carry very low risk. You can withdraw your money without any exit load (after 7 days).
An easy way to assess the risk is to observe the Net Asset Value (NAV) movement. NAV is the value of an entity's assets minus the value of its liabilities. How do you do that? Once you narrow down the liquid fund that you want to invest in, observe the graph. A linear graph indicates low volatility, which means low risk.
If you'd like to know more about these funds, here's a useful link : https://www.moneycontrol.com/mutual-funds/performance-tracker/returns/liquid-fund.html
Overnight funds is yet another option that you can explore. Overnight funds are debt funds that invest in debt securities with overnight maturities. These are safe and carry very low risk. Returns and expense ratio are two parameters used to evaluate these funds. Expense ratio is the per unit cost of managing the funds. The net return to an investor is calculated after subtracting expense ratio. Therefore, always look for a low expense ratio to maximize your returns.
I hope this post was useful and inspires you to start investing in your emergency funds, today. Pay day is almost here! Good luck..