1. Do you really need an emergency fund?
The importance of setting up such a fund cannot be exaggerated. It is often argued that you don’t need emergency cash if you have a credit card. A credit card does come in handy when you face a financial crisis, but the cushion that plastic money provides lasts only 15-30 days, till the bill arrives.
2. How big should the corpus be?
Your emergency fund should be large enough to take care of your living and other essential expenses, such as house rent, school fees, health care and insurances, for 3-4 months. A corpus smaller than this defeats the purpose of setting it up. Some financial planner’s advice putting away 8-9 months expenses for contingencies.
3. Where should you invest the money?
There was a time when gold was seen as the safest investment for tiding over bad times, but parking emergency funds in it is no longer a prudent decision. Gold give negative result in 2013 and 2014 is not being any different. Instead, the emergency fund should be stashed in a liquid option, such as a sweep-in bank account or an ultra-short term debt fund. The money in a bank account or sweep in account is immediately available, while the redemption proceeds of debt funds reach your bank account with in one working day.
4. How to save for the contingency fund?
Don’t try to build the corpus too quickly. It will be burden on your cash flow and derail other plans, such as saving for retirement or child’s education. If you have not established an emergency fund, start putting away 10-15% of your monthly income for this purpose. This will helps you build a corpus in about two years. Any windfall gain, such as a tax refund or an annual bonus, should also be diverted to it. However, this is important that this amount be treated as sacrosanct.