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WHY HAVING AN EMERGENCY FUND WILL MAKE YOU HAPPIER

Hansi Mehrotra
October 27, 2015

Just when there are studies that show that money doesn’t lead to happiness, how can I claim that having a stash of emergency money will make you happier? Actually, the studies refer to money above a certain level. Everyone needs some money to cover basic physical needs (like food, home, clothing) and security needs (like education). Personally, I have another need – the choice of working in an area and with people you want. Let me explain but first things first.

 

Being one accident away from bankruptcy

A study shows that one out of ten US families is bankrupt, i.e. they owe more than they own. Another ten percent households have a net worth of less than $4,300. Indeed, one-third of all American families are either already bankrupt or just one ‘accident’ away from it. The accident could be a physical one like a traffic accident, a medical one like being diagnosed with something unforeseen, or a work-related one like being laid off or being plain fired. So, one in three people live from paycheck to paycheck and would be bankrupt in case something bad happened. There are many more who simply use their credit card to take on debt at more than 20% pa interest.

Given the huge disparity of wealth in India, I would presume the numbers could be similar. People at the lower end of the pyramid, who don’t have credit cards, are forced to borrow from moneylenders at exorbitant rates. I certainly know many people like that.

I also know of many others who work in jobs they hate – either because of the kind of work, or the people they work with. But they can’t quit because they can’t afford to be without a job, even for a few days. There are women who stay in bad marriages because they cannot afford to start a life of their own.

Surely, that’s not happiness!

 

Start your foundation with an emergency fund

If you are in this situation, you need some financial planning. But the first step in any financial plan is to protect yourself and your family, for which you need two things – insurance and emergency fund. You need life and health insurance – you may want to read more about insurance. You also need an emergency fund – even if you have insurance.

Depending on your insurance and other assets, the rule of thumb is the emergency fund should be 3-6 months’ income. This equates to a higher number when calculated based on expenses – I recommend 6-12 months’ expenses.

You need to increase this figure yet again if you are self-employed, or a high salary earner. The reason being – the more senior you are, the longer it takes to find a job.

 

How to invest emergency funds

Since you might need to use this money in a hurry, make sure it’s liquid. So you can keep it in a savings account, or fixed term deposit. Generally you will have to forego part of the interest if you break a fixed term deposit; I think it’s a small price to pay in an emergency. You can also invest in a liquid mutual fund, called ‘cash’ or treasury funds – so called because they invest in short term government paper. Do not get talked into short-term income funds, which tend to invest in corporate bonds and may experience liquidity issues in times of crisis.

Indian women tend to hoard gold jewelry. My theory is that they see it as their emergency fund. I don’t think it’s a bad idea, given the circumstances. But in a true emergency, they might find that it takes time to convert the gold into cash. Perhaps they could diversify a bit and keep part of it in a savings account – one that is only in their name.

 

When to use emergency funds

By definition, the emergency fund should be used for emergencies. Examples of an emergency could be paying hospital costs in a medical emergency when your insurance claims take time, or paying your monthly living expenses if you can’t work and you don’t have any leave or income protection insurance. It could be, to fix a burst pipe in the home, or the car, if it’s your only mode of transport. But it’s not a good idea to use it to redecorate your home, buy a new car, or go on a holiday just because you ‘neeeeed a break’.

Trust me on this one – having some money available if and when accidents happen, will allow you to sleep better at night. It’s worth foregoing some fun right, now to build this emergency fund.

And if you think you can always borrow some cash from a relative or friend when in need – which most of my Indian friends do – don’t you think you should also be able to help them out when the need arises? Giving help will give you more happiness than receiving it.

So go ahead and get started on your emergency fund right now.

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