How much emergency fund do you need for emergencies?

ByViplav Majumdar

Planning Emergency fund is the first step towards financial planning of family, there are many reasons to maintain an emergency fund in every family. Its a million dollar question that how much emergency fund my family needs. There is no simple formula to this question, it depends on the financial situation of the family and many other factors like

  • Your dependents who may need your assistance at the time of emergency
  • Present and future marital status
  • How many earning members are there in the family
  • Type of occupation (for cash flow)
  • Stability/security in occupation
  • Expenses
  • Chances of extreme medical emergencies
  • Increase or decrease in expenses in near future
  • Aspirations
  • Many more

For families in middle-class regular income is the most important factor for the base of financial planning and financial future of the family. For middle-class career is the main source of income, savings from this income gives you wealth if used wisely. So, in any case, the priority should be to ensure good career with longevity, as we know; the emergency fund supports us in many ways so it’s vital to maintain the right suitable amount as an emergency kitty for the family. For calculation of this, we shall focus on some key factors.

Personal situation of family

While determining the right amount, we need to know the dependents in the family, then evaluate regular and sudden or urgent requirements (if known) of all the defendants in the family. Some families may have senior members of both the spouse or some may have a nuclear family. It’s been observed that some families have senior members with regular income but for medical or other emergencies they depend on their kids. In general families with young bread earner to mature bread earner, the requirement of this kitty increases with age and responsibilities.

Empty nesters where kids have left their homes need more amounts for urgent needs as the distance and travelling costs should also be considered. For this calculation, travelling cost should be increased by 20% and air travel cost should be considered, to be on the safer side.  Addition of a family member increases your regular expenses and emergency requirement too.

Medical History

Regular monthly cost of medicines can be taken in monthly expenses for calculation of the right amount of emergency fund. Many families have a medical history of Diabetes, Blood pressure, Heart or Cardiac problems, problems related to kidney, etc. In these families, there is always a risk of the medical emergency, which may need a lot of funds for the care of the member. This amount should be added to the normal emergency fund. It’s a cause of huge concern where there is more than one member with medical history. This factor should be evaluated very carefully. This is why people should plan health insurance properly at the appropriate time.

Professional Situation

Salaried

Our profession has great influence on our need of emergency fund. Every family needs a stable career for to secure financial future of the family. Salaried people should start to realize their relationship with their employer from employer’s perspective and check their use for an employer in years come while keeping the tough competition from colleagues and others in the job market, this will help in long run. It also depends on the term of notice period in your organization for calculation of this fund. Ideally, 6 months of expenses should be sufficient as a contingency fund for a normal salaried family. If one is competent enough, one should get a good opportunity in six months period.

Self Employed

For people working as self-employed the need goes up, they get paid on their own brand only, they suffer or enjoy the ups and downs of their profession. So they should consider their fixed running expenses in their setup for self-employment, like a doctor, lawyer, an architect, shopkeeper, owner of a beauty parlour may have fixed liability of staff, electricity, phone, rent, which are to be paid in any case. Self-employed people must consider these expenses. Unlike salaried people self-employed people if don’t work for a period, they have fixed expenses of family and setup but no income for that period. For these people timing of cash flow is also very important, some people realize money monthly or some may realize it once a year. These people should keep emergency fund equivalent to 6-9 months of expenses.

Businessmen

As we know businessmen have professional teams to run business, many times it’s been observed that they failed in one business and got the setback for life. On the opposite side, some people jump back from this odd situation. The key is an emergency fund, these people should park funds equal to their 2 years of monthly expenses and an amount which can be used to start a new venture. For this cause, the investment and assets in running a business should not be considered. Although one may feel that starting a new business may need a large amount. This can be achieved gradually with proper financial planning for businessmen.

Earning Members

To ascertain the right amount of fund for contingency we need to look into the number of earning members in the family whose income can be considered for the particular family. Income of kids beginners in a career should not be considered. A situation where there are more than one earning members in the family gives some relaxation in terms of the amount of emergency fund. As there are fewer chances of becoming ill at the same time for all the members. For calculation of funds contribution amount of the members can be multiplied with the notice period in job or 6 months. Every individual earning member should maintain funds in own possession.

Career Plan

The process of Financial Planning starts with a career plan, your career plan affects every aspect of your life in present or future. For calculation of Emergency fund we need to evaluate the career plan, if you are planning to switch job, become a self-employed leaving job or leaving a job for kids. These situations will increase the requirement of funds for contingency. Career plan of all the earning members and its impact on the cash flow, the liquidity of family must be considered while calculating emergency fund and adjustments should be made to make yourself comfortable.

Aspirations

Like career plans, aspirations of all the family members should be evaluated as these can substantially increase regular expenses of the family.  Like, increase in lifestyle effects you with lifestyle increase and inflation, in the long run, it is higher than the returns you make on your investments. This can negatively impact the financial situation of the family resulting in the rat race.

How to calculate Emergency Fund

For calculation of regular monthly expenses, one needs to calculate the expenses on yearly basis. Ask yourself a question, how much do you spend monthly? You must have got some reply in your mind, now if I ask you, have you considered Life insurance premium, your car insurance, health insurance, loan EMI, medicines, travelling cost, the regular maintenance cost of a home, electricity bill, vacation, gifts, etc? You might feel some heads were missing in the calculation. So the annual expenses should be calculated and to arrive at monthly expenses divide it by twelve. If a normal salaried family has monthly (calculated annually) expenses of Rs. 50000, they will need total Rs. 3 lacs as an emergency fund, Rs. 50k at home and Rs. 2.5 lacs in liquid assets.

Emergency fund can’t remain same for your entire life, I have given these factors so you can evaluate your situation periodically and make changes in your emergency fund to enjoy life with freedom. Financial Planning gives you peace of mind with control on your finances.