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Emergencies do not give you a warning before showing up. This is what I was explaining to a fellow investor recently. The discussion really was about keeping aside an emergency corpus before building the risk portfolio.
If you are a young earner reading this blog, you may be wondering why this is relevant to you. Often one feels that it is too early to start thinking of an emergency fund. There is support from parents and there is the need to build wealth through growth assetsGrowth assets as against fixed return assets are those which grow your capital or principle investment. The most common forms of growth assets are equity stocks and property. Investing in equity stocks means you buy a portion of the underlying... More; earlier the better. Why waste surplus funds on building an emergency corpus which will get invested in low but stable return investments?
I had another conversation with a gentleman this morning about a close acquaintance of his undergoing stent surgery worth ₹50 lakh. Clearly, if you are in your 20s the chances of you undergoing stent surgery are very low, but what about your parents? The amounts involved in such procedures can be astronomical and often beyond the medical insurance plan in place.
Remember the Chennai floods from a few years ago? People I know personally, young couples, underwent great financial loss because their homes were flooded with water. Furniture, documents and basic electrical fittings were all destroyed. To restore this and in some cases the entire home, one needs emergency funds.
There can be so many other reasons; unexpected job loss, tax man comes calling, your sister needs urgent medical treatment, your brother needs money to start his business, a car accident where you recover only scrap value or pipe leaks which require relaying resulting in the entire bathroom being torn down and redone and so on.
My argument still remains that building an emergency fund should take priority no matter what your age is or whether or not you have that wealth creation cushion.
Ideas to build that emergency bucket
You can start by taking 20% of your monthly saving and putting it towards an emergency fund. Ideally, don’t build the emergency fund in isolation, do it simultaneously with your growth portfolio. It is still important to start early where wealth creation investments are concerned.
Let’s say you can save up to 30% of your ₹40,000 monthly salary. Take out ₹8,000 from that and put it aside in a fixed or stable return investmentAn investment is made to give you a return. You make an investment if you use your money to buy either physical assets like property or financial assets like bonds and equity with an aim to receive income or gains... More of your choice.
You could go with a fixed deposit or if it is too cumbersome to have fixed deposit on a monthly basis, try doing a systematic investmentAn investment is made to give you a return. You make an investment if you use your money to buy either physical assets like property or financial assets like bonds and equity with an aim to receive income or gains... More in a short-term income fund or even a recurring deposit in a bank if that is what you are comfortable with.
It will take you a year to save up to around 2.5 times your monthly salary.
Then comes any lump sum inflows like bonus; ideally you should be able to save at least 50% of your bonus if not more. Let’s say you get ₹1,00,000 as a bonus, use ₹50,000 for the spends you ear marked and invest the rest. With the investmentAn investment is made to give you a return. You make an investment if you use your money to buy either physical assets like property or financial assets like bonds and equity with an aim to receive income or gains... More amount take out ₹10,000 or 20% and invest towards your emergency corpus. Roughly with two years of starting this exercise you should have around 6 months of your salary (including increments) saved in an emergency fund.
Once this is done, you may choose to reduce the monthly contribution to 15% of savings for another 2 years and then 10% of savings. What you reduce here can get added to your growth portfolio.
With bonuses and increments included within five years of your earning life, you can potentially build a corpus that equals about 12-18 months of your monthly income.
It’s a shield
Once in place, not only are you better equipped to deal with emergency spends that crop up from time to time, but also you have a mental cushion.
Knowing that this money is available any time and in secure investments, you will feel more confident in taking on some calculated risks for your long-term portfolio.
Over a period of time this can help in building a portfolio which can help accumulate equity gains.
Hence, your emergency fund, if unused for a while can act like a shield that help you move forward at a better pace on the wealth creation agenda.
Plans don’t always work out. You could get lucky with your equity investments and have gains in the first few years which themselves act as a surplus towards emergencies. Alternatively, an emergency expense could come in the initial years, that’s way higher than all your savings put together.
Undoubtedly, it is hard to foresee a precise path for wealth creation or even financial security. What is in your hands is the ability to be prepared. Change your actions along the way as required but at least do the bare minimum that you know will be useful.
This bare minimum in the order of actionables is as follows:
- Start saving early
- Focus on building an emergency fund
- Invest early for long term wealth creation
Do these three things first and then move ahead with the rest of your financial plan.