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Financial responsibilities in middle-class families are always a complex maze. When you have huge home loan EMIs to pay every month, ever-increasing children’s school and tuition fees and regular health care of your elderly parents, life runs on a tight budget. In such a situation, the entire household budget can collapse due to sudden job loss, salary cut or any unexpected medical crisis in the family. Financial advisors often give the general advice of keeping an emergency fund equal to 3 to 6 months of expenses, but where the number of dependents is high and the debt burden is on the head, this traditional formula proves to be a complete failure. In such a sensitive family structure, it is essential to have liquid funds to cover at least 9 to 12 months of essential expenses.
Often people make the mistake of deciding the size of their emergency fund based on their total in-hand salary. The basic rule of financial planning is that emergency funds are meant only to safeguard those unavoidable expenses which cannot be avoided or prevented under any adverse circumstances. When a person’s regular source of income stops, the first thing to stop are non-essential expenses like eating out, weekend trips, OTT subscriptions, buying clothes and gadgets. So while deciding the fund size always list your basic liabilities. This includes the monthly installment of home loan, maintenance of flat or house, electricity, water, LPG, ration and grocery, children’s school and tuition fees, parents’ essential medicine bills and insurance policy premiums.
Suppose the total mandatory monthly expenses of a working family are around ₹1,10,000. This includes home loan EMI of ₹40,000, household ration and basic bills of ₹30,000, children’s education expenses of ₹15,000, medicines and caretaker expenses of ₹15,000 for elderly parents and monthly provision of ₹10,000 term and health insurance. If there is only one earning member in this family and the number of dependents is three or more, then a buffer of 6 months works out to ₹6.60 lakh, which can be exhausted very quickly in such a recession when it takes 8 to 10 months to get a new job. In contrast, a 9 month protection cycle would be worth ₹9,90,000 and an ideal 12 month protection cover would be worth ₹13,20,000. This fund of ₹13.20 lakh gives the confidence to keep the family safe from all pressures for one year without taking any loan or selling the property.
Leaving a large sum of Rs 10 to 13 lakh in an ordinary bank savings account is financially disadvantageous, as the simple interest of 2.5 to 3 per cent does not keep up with the inflation rate. For this, it is considered most practical to divide the money into three different buckets. The first bucket should be of immediate cash, in which about 15 to 20 percent of the total funds i.e. about Rs 2 to 2.5 lakh should be kept in bank accounts and auto sweep-in fixed deposits, which can be withdrawn from ATM or UPI even at midnight. The second bucket should be of short-term security, in which about 40 percent of the amount should be kept in bank FDs of different tenures which can be withdrawn within minutes without any penalty through mobile banking. The third bucket should be the remaining 40 percent amount, which should be parked in debt liquid mutual fund or ultra-short term fund, from where the money is withdrawn and transferred to the bank account within one working day and returns are also better.
If your home loan is under Maxgain of State Bank of India or home loan overdraft facility of any other bank, then managing your emergency fund becomes very easy for you. You can keep a large portion of your emergency fund (say Rs 5 to 7 lakh) directly deposited as surplus balance in your home loan overdraft account. This gives double benefit. First, for the number of days this extra money remains in the account, the bank will stop deducting that part of interest on your principal amount, which will directly save you lakhs of rupees of interest and the loan tenure will reduce rapidly. Secondly, it works like a completely liquid fund, which can be withdrawn instantly as and when required without any extra charges through chequebook, net banking or ATM card.
In case of senior citizens, health complications can suddenly demand a huge amount of money. Corporate health insurance or general family floater policies for seniors above 65 years of age often have co-payment clauses, room rent capping and sub-limits on critical illnesses. If the hospital bill comes to ₹8 lakh and the insurance company passes only ₹5 lakh, the remaining ₹3 lakh has to be paid out of pocket. If you don’t have a dedicated medical buffer of ₹3 to ₹5 lakh set aside, your entire household emergency fund will be exhausted in a single hospital bill and the home loan installments will be on the verge of default. Therefore, keep a standby health reserve ready for your parents with a separate senior citizen health policy.
Emergency fund is only a solution in case of stoppage of income, but in case of any untoward incident with the main earning member of the family, this fund cannot provide long term support. So until the home loan is in order and the children are on their feet, it is legally and financially mandatory for the breadwinner of the family to have a term insurance cover of at least 15 to 20 times his annual income. Along with this, many financial institutions offer Home Loan Protection Plan (HLPP), which ensures that in case of untimely death of the main borrower, the insurance company directly repays the outstanding loan of the bank, thereby keeping the roof over the head of the family safe and the education of children or the upbringing of the elderly is not affected.
If you don’t have any solid savings today and are just balancing EMIs and expenses every month, building a corpus of Rs 10 or 12 lakh at once may seem impossible. But it can be divided into smaller parts like a goal-based SIP. First of all, aim to create a mini-fund of one month’s expenses i.e. ₹ 1 lakh. For this, auto-debit 10 to 15 percent of your income every month into a recurring deposit (RD) or liquid fund. Put annual bonuses, tax refunds, incentives or any unexpected income directly into the emergency fund bucket. As soon as the first 3 months of expenses are secured, in the next phase build up a complete security fund of 6 months and then gradually within 24 to 36 months. This discipline provides financial freedom and unwavering mental peace to your family.