Tuesday, 22 May 2012

Financial Plan - Emergency Fund and Insurance

Image(s): FreeDigitalPhotos.net
Do you love your Dad or your Mom? Ask this question to a baby or kid, i bet the answer is not always consistent. Dad could be the answer in morning and Mom in afternoon. The question seems to be simple but the answer is not. It’s a tough call; baby would or may love both parents equally.
I was in similar situation when my friend Sanjeev asked me a query- Here goes the query:
Now that I understand Financial Plan is very important, what should be my first step? Should I build Emergency Funds or Buy a Term Plan? 
Honestly During my conversation with him, I did flip my answers. It was indeed a tough call to make. Logically speaking both should have same priority. Both should have the same beginning. Sanjeev was adamant, wanted me to pick one of the two. The answer should be objective.
A bit of background:
Sanjeev who recently got married, his life partner “Neeta” is house wife. After all the monthly expenses he would be left with 25k per month. The little savings he had was all spent for his own marriage.
Considering that Neeta is dependent on Sanjeev, my objective answer was to start off with buying a Term Plan. In case of Sanjeev’s untimely death, Neeta will end up in deep financial crisis. For Sanjeev it is not important but critical to buy Term Plan for himself.
Click Here to know more about Term Plan/amount of cover, etc.
His next question was "When I have term Plan, why do I need emergency fund”? I responded back saying; this cannot be answered in objective way. I need to be subjective. He was kind of OK with it.
  • Let’s understand what Emergency Fund is:Emergency Fund is something that should be used to meet your emergency needs that might otherwise adversely impact your physical or financial wellbeing. This fund is NOT for meant for buying anniversary gifts or celebrating your angel/prince’s first birthday. In case of unforeseen situation this fund will protect you from getting into high interest debts like Credit Card or Personal Loans.
  • What is the right amount?There is no perfect answer for this. This depends on various factors. If you are the sole earner in your family, your emergency fund should at-least be 6 to 8 times your monthly expense. In case of Job Loss, these funds will help you sail through till you get another job. If you have a working spouse you have an emergency fund that is 3 times your monthly expense. 
  • Word of Caution:Once you succeed in building the necessary funds, don’t be tempted to utilize this fund for vacations or down payment for your flat. Don’t dilute the purpose of this fund. Let us re-iterate that Emergency funds should be utilized only in case of emergency situation. The idea is to have this money in liquid form. It is Ok if this money earns lesser interest than your fixed Deposits.
  • Best Way To Build This Fund:Start off with smaller target/goals. Aim to build the funds gradually. Have a realistic target. Every month divert few thousands towards Emergency funds. In case you get additional money in form of bonus or hike, divert your money towards emergency funds. The process of building emergency funds should be just like baby steps, One step at a time. Make sure you keep moving.
  • Where should I park these funds?Remember - Equity is NOT always the answer for parking or building your funds.  Recurring Deposit is one of the safest and best ways to build money. Savings Bank Account is one more option. Off late there are quite a lot of banks that are offering attractive interest rates. More over the interest earned up to 10k is exempted from tax. Mutual Fund Savvy people can tap into Liquid Funds to build Emergency funds.
    Click Here to know more about Recurring Deposits.
    Click Here to know more about Liquid Funds.
Any Important Tips:
  • Separate Account for Emergency funds:Open a separate account exclusively meant for emergency funds. The day you get your salary, divert specific amount to this account. Good if you can automate this. Don’t opt for ATM card. Check book is good enough. With ATM you have easy access to this money and we might end up spending this money in some non emergency situations. Let’s understand this is only for emergency.
  • Realistic Milestone: If you’re Goal is to build 5 Lakh. Break this journey into smaller milestones of 50k each. Initially Plan off for 50K. Once you achieve this, aim for next target. Setting Up a big goal and not achieving it, for sure will demoralize you. Let’s have SMART GOALS.
Note: This is cooked up story, the article intends to highlight Emergency Funds and Term Plan as two important aspects of financial plan.
Do you have emergeny funds? Do you agree emergency funds and Term Plan as vital for sound financial Plan?


Vivek Hingorani said...

One suggestion is that you can get sweep in facility activated with a private bank. You get more interest(similar to FD) and if you need emergency fund you can liquidate it immediately.. I have done the same...

WealthUCreate said...

Hmmm... As long as you are respect the nature of Fund "only for emergency", any approach you take is fine.

The logic behind saying - Cheque book is enough - just to make it hard to access.

I agree Sweep Facitly - you can earn more interest. I have written an article on how it works and advatage of it.

Vivek Hingorani said...

Can you share that link with me please

WealthUCreate said...

Just give the word "sweep" in search box you would get it. Here is the link.


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