If you speak to any qualified financial advisor, the first thing they suggest is to have an emergency fund. They recommend keeping your monthly expenses of six months to one year in the bank as a fixed deposit or park them in a liquid mutual fund.
The idea is to deal with an emergency without hurting your long-term savings or investments.
However, if one has to follow the trend in the mutual fund sector, individual investors have just over Rs 13,000 crore invested in liquid funds. If we assume two crore unique investors, then Rs 6,500 is invested in liquid funds per person.
In comparison, the value of the retail investment in equity-oriented mutual funds is Rs 4,46,000 crore. The average investment per retail investor is Rs 2,23,000 in equity markets. Even in the high-net-worth individual (HNI) category, there is a clear preference for equity-linked assets. HNIs are people investing Rs 5,00,000 and above.
The preference of equity over liquid funds suggests that emergency funds are saved in fixed deposits or a saving account. For a good number of people, there is perhaps no emergency fund. It also shows that investors are thinking of long-term capital growth and have barely thought through about emergencies in the short-term.
What is an emergency fund
An emergency fund is essentially money that is available for you in case of sudden hospitalisation, job loss or any other need. Opinion varies over how much should be your emergency fund. If you have a steady income, experts recommend at least six months to one year expenses to be held as an emergency fund. However, that is easier said than done for most people. As the data suggests, investors want to deploy savings in instruments that offer better returns. Money lying in the bank is considered idle.
The concept of an emergency fund may vary for individuals.
A friend uses his multiple credit cards as an emergency fund. He argues that breaking investments suddenly can hurt the long-term value of wealth. In a panic situation, you may end up selling suitable investments. He said that he utilised the 30 to 45 days interest-free credit given by credit cards for emergency hospitalisation in the past. He then carefully looked at his portfolio and sold investments that were underperforming to pay off the credit card bill within that interest-free time limit. However, this may not work for everyone.
Credit card limits vary with individuals. Use of credit card helps people who have no loans. If you are already paying EMIs, you may hesitate to use credit cards. In such a situation, you may have to plan for an emergency fund. Financial advisors will often tell you that any surplus money you get, you must allocate to your emergency fund. If you are young, you may not be interested in saving and investing. You immediately dream of spending that bonus on your loved one or holiday.
The importance of an emergency fund needs to be explained to the young. It is easier to start the habit when young as you have limited responsibilities. It is hard work to create one in the 30s and 40s as expenses rise.
In the United States and other rich countries, companies are encouraging employees to maintain an emergency fund to protect retirement savings. Some have begun to make contributions to such a fund, according to recent reports. Healthcare cost for the elderly is rising all over the world. Whenever there is a family emergency, people dip into their retirement savings. That leaves limited funds for maintaining their life after retirement. Considering the rise in life expectancy, people have to provide for 20-30 years after retirement.
The data clearly shows that it is hard to work on an emergency fund for many individuals. A solution to this could be to set aside a portion of your provident fund or the National Pension Scheme as an emergency fund. There could be a lock-in for withdrawal for the first five years. However, later, it can be made available to individuals for removal. You can restrict partial ‘drawdowns’ on these plans if an individual utilises the emergency fund.
Appropriate government intervention may trigger a habit that could have long-term implications on the way people save for emergencies.