Get insurance, and follow it up by building an emergency fund you can dip into without touching your investments
A common mistake that people make is treating physical assets such as real estate and gold as storehouses for emergency funds
Last week, the newspapers were strewn with images of Jet Airways employees mourning the airline’s shutdown. The shock and trauma writ large on the faces of the 16,000-plus Jet Airways employees, who have suddenly found themselves in the middle of a financial emergency, has a lesson for everyone: to prepare for such a situation.
Job loss is only one kind of emergency that can catch you unawares. Medical emergencies or, worse, the death of a family breadwinner can also put a family’s life and finances in jeopardy.
So how do you prepare for emergencies? The first step towards putting a contingency plan in place is to get insurance. Follow it up by building a money box that you can dip into anytime you want, without touching your goal-based investments.
Health insurance: The only way to combat medical emergencies is to have adequate protection, given the rising cost of healthcare in the country. Most companies today provide health insurance cover to their employees, but being solely dependent on that can be risky. For instance, in case of a job loss, the cover will cease to exist, and in case of a medical emergency at such a time, it could prove to be a double whammy for you.
“You can start by buying a minimum of a ₹5 lakh individual cover when you are in your 20s, and upgrade as soon as you are married. You can buy a higher cover economically by coupling super top-up policies," said Mahavir Chopra, director of health, life and strategic initiatives at Coverfox.com, an online insurance platform.
Life insurance: If you are an earning member of the family and have dependants, taking adequate life insurance cover as part of your contingency plan is a must. It will see your family through in case of any untoward incident.
“One should buy a term insurance with minimum coverage duration up to retirement. The coverage should be at least 10-15 times your monthly expenses and also cover long-term liabilities like home loans," said Chopra.
Once you have decided to build that money box, it is important to know how much is enough. The amount may largely depend on the nature of your job if you are preparing for a job loss. “If you happen to work, say, in an IT job, where there are plenty of job opportunities, you can keep aside three to four months of expenses. But if you are in a specialized job (where opportunities are fewer), then you should increase your corpus accordingly ," said Lovaii Navlakhi, managing director and CEO, International Money Matters Pvt. Ltd, a financial planning firm.
If you have enough in your money box, it can help you tide over other emergencies as well. But ensure that you are able to access it at short notice. A financial emergency will not give you enough time to unlock your portfolio tied into equity that’s volatile and other products with lock-ins. So it’s better to put your money in debt funds or fixed deposits.
Among debt funds, you can choose between liquid and ultra short-term funds. “For people in the higher tax bracket, ultra short-term debt funds make more sense in the long term compared to fixed deposits as the relative advantage on post-tax returns is higher," said Mrin Agarwal, founder director of Finsafe India Pvt. Ltd and co-founder of Womantra.
If you want less risk, opt for liquid funds. “I’d say all of your emergency corpus should be in liquid funds," said Navlakhi. Liquid funds invest in scrips that mature up to 91 days and are considered less risky than ultra short-term debt funds.
If you are someone who is still getting used to the idea of mutual funds, you can stick to the good old bank fixed deposits (FDs). They may give lower returns than debt funds and are not as tax efficient, but are still better than savings bank accounts. You may want to divide your corpus into separate FDs of different tenures to make the most of them.
What to avoid
A common mistake that people make is treating physical assets such as real estate and gold as storehouses for emergency funds.
Real estate is the least liquid asset and selling it when you need the money may be difficult. Worse, a distress sale can hit your returns. “Selling real estate should always be the last resort as it’s not easy to sell it. More often than not, it happens to be a distress sale. So real estate can’t really be relied upon," said Agarwal.
Physical gold is easier to sell, but getting the full value may be a challenge. The buyer will always deduct making charges when you sell physical gold, including jewellery and bars; the purity of the metal may also become an issue. “Gold can be used in your emergency corpus as it can be liquidated easily. But you should have the ability to sell it. The problem with gold is that people get attached to it," said Agarwal.
Remember that building an emergency fund is not a one-time exercise. You need to review it periodically as your salary increases or as you have more dependants. If you dip into your emergency fund for any other purpose, make sure you replenish it adequately soon after.
The images of Jet Airways employees were strong enough to shock you out of complacency, so start preparing for a financial crisis now.
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