Saturday, January 20, 2007

Set Aside Emergency Cash

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Series: Beginning Investing (8th post)
Section: Before You Invest
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Now that you have productively used your monthly savings in reducing your debt and purchasing adequate insurance, there is one last thing to take care of before you move on to investments - setting aside emergency cash.

Though the risk of losing your income is low, life is uncertain and any number of things may come up to disrupt the normal course of things and force you to take a break from your job. It is also possible that you may need extra cash to handle an emergency or just to take advantage of an unexpected opportunity.

For such situations, it is important to have a cash buffer. The amount you set aside is up to you, but given the primary purpose of having sufficient liquid funds to tide you over in case you lose your income, I would suggest the minimum you set aside should be enough to cover 6 months of regular expenses, as determined based on your expense analysis earlier.

These funds need to be readily accessible and risk-free, and hence should be kept in a bank account and not as a fixed deposit or in high-risk investments. You may not earn much from this money but that's not an issue.

This concludes the section on things to take care of before you invest. The main purpose of these last three posts was to ensure a fallback plan for you and your family in case of trouble, a conservative approach that will allow you to invest your money secure in the knowledge that you have provided well for the people that depend on you.

Next Post on Beginning Investing: How Much Risk Are You Willing to Take?

15 comments:

Anonymous said...

You could use FDs linked to savings account. The liquidity of such FDs is exactly same as money in savings account, but it gives better interest. I know that ICICI bank offers such FD (Called MoneyMaximizer account) I am sure other banks also would be offering them.

Sanjiv Singhal said...

Amit

Having emergency cash should be translated as "access to cash in a hurry". I don't believe you actually need to have it as cash sitting in a bank account any longer.

Before I explain this, lets understand that there are two different and distinct requirements that you are suggesting planning for.

1. Emergency cash for contingencies such as health emergencies, unplanned expenditure such as travel etc
2. Temporary loss of income

For the first, your credit card limit (if you are managing your debt smartly, it should all be unutilised!) should cover most if not all of your emergency cash needs. The payment period for settling your card bills is usually long eough for you to convert your financial assets (bonds, stocks, whatever) to cash.

Cash for tiding over temporary loss of income is not really emergency cash. That is what your investment are for and there is no reason you should block that much money in low return bank accounts.

As you can see, I am not a big fan of savings accounts :)

Sanjiv

Prasanth said...

Amit,

The series is great reading. Please continue. Thanks

Bernard said...

Alternative to FD is T-bills or Treasury Bills. They tend to have higher interest rate than FD and is more flexible than FD in term of withdrawal.

Ridhima said...

That is true.. Everyone must plan their retirement well in advance. Foe more details on retirement planning you can go to http://www.apnapaisa.com/category/financial-planning/retirement-planning-financial-planning/

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Aditya said...

Amit,

I really like this series, please continue the good work. But, on the other side, setting cash for emergency is somewhat nonsense, like if one wants to save then they can switch off fans, a/c's and all, just as the video's i've been watching in the noon. Have a look at the site, may be some new ideas creep up! Good Luck. www.kanjoosi.com

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