Arthgyaan

Supporting everyone's personal finance journey

SMART goals: how to create an emergency fund

An emergency fund is essential to protect yourself from unexpected problems where a lot of money needs to be spent. This article will show you how to create one step-by-step.

SMART goals: how to create an emergency fund


Posted on 05 Oct 2022
Author: Sayan Sircar
8 mins read
📢Join 2400+ readers on WhatsApp and get new post notifications!

An emergency fund is essential to protect yourself from unexpected problems where a lot of money needs to be spent. This article will show you how to create one step-by-step.

SMART goals: how to create an emergency fund

📚 Topics covered:

SMART framework for Goals

What are financial goals

We have covered why we need to set goals before investing in this post: Set a goal before looking for what to invest in.

This post uses the S.M.A.R.T framework to ensure that goals are set in the right way so that you can move on to the next steps of goal-based investing: I am now ready to do goal-based investing. What now?

The S.M.A.R.T framework has the following five components. We will discuss one by one:

  • Specific: Why do you need the money?
  • Measurable: How much money do you need?
  • Achievable: Can you do it? Do you need help?
  • Realistic: Can you reach this target based on where you are?
  • Time-bound: When do you need the money? Is the timing flexible?

If the goal is missing one or more of these attributes, you cannot invest for it meaningfully. In this post, we will apply the S.M.A.R.T framework to create an emergency fund.

Specific: Why do you need the money?

You need a way to pay for expenses caused by an emergency. An emergency is defined as something that is unexpected, sudden and can cause a lot of money to be spent like:

  • medical emergency
  • vehicle accidents, damage or flooding
  • sudden repairs/theft
  • job loss
  • flood or cyclone damage
  • short notice travel to support a sick family member or friend
  • Murphy’s Law: “what can go wrong will eventually go wrong.”

An emergency fund prevents the requirement of new debt: both personal loans and worse credit cards have extremely high interest rates. If you already have loans, having an emergency will severely strain the monthly budget. People who earn and save well sometimes take their good fortune for granted and ignore having an adequate emergency fund. It is one of the axioms of personal finance?.

What is NOT an emergency:

  • discretionary purchases like items on sale or entertainment
  • leisure travel
  • planned expenses like a car purchase. You should either use a sinking fund or use goal-based investing for that

Did you know that we have a private Facebook group which you can join for free and ask your own questions? Please click the button below to join.

Measurable: How much money do you need?

The size of the emergency fund is measured as multiples of monthly expenses like

  • mandatory expenses like rent, groceries, transport, utilities, school fees and other similar items
  • any EMI like home, personal, educational or credit card loan

The fund does not include discretionary items like entertainment, subscriptions and eating out.

There are three schools of thought on the size of the fund in multiples of monthly mandatory expenses and EMI:

  • 3x expenses at the minimum
  • 6x expenses as the standard amount
  • 12x expenses if your job is uncertain, income is irregular or if you have a home loan

If you are saving 6-12x home loan EMI as a part of your emergency fund, explore if an overdraft scheme, like SBI Maxgain, will be beneficial.

Achievable: Can you do it? Do you need help?

An emergency fund lets you sleep well at night.

This is like wearing a helmet or seatbelts. You will not need it every day but on the day it is needed, you will be extremely glad that you have that protection.

Emergency fund estimation varies between people:

  • Those who have faced an emergency overestimate the need
  • Those who have not yet (god-forbid) underestimate the need and try to maximize returns for this money

If you specific guidance on paying off loans or budgeting with irregular income, refer to these resources:

Realistic: Can you reach this target based on where you are?

monthly surplus = income in hand - mandatory expenses

How much to keep in an Emergency fund

You should aggressively start saving most of the surplus to build up the emergency fund until at least 3x is saved. Do not invest in long-term (>5 years) goals until at least 6x is saved.

Divert all bonuses, gifts etc., into building your emergency fund until you reach at least 6x. If your spouse does not have any income, please consider a slightly higher allocation to your emergency fund.

You can consider a psychological hack keeping one year of children’s school fees in a separate bank account as FD. This FD will give you peace of mind that your children’s schooling will not be interrupted due to any emergency.

Time-bound: When do you need the money? Is the timing flexible?

There is no absolute time limit to creating your emergency fund. However, given the concept and purpose, the priority, once you start earning money, will be to reach the 3x expenses value as early as possible preferably within 6 months.

When an emergency fund is:

  • Less than 3x: save the entire monthly surplus after expenses and EMI
  • More than 3x and <6x: divert half the surplus to high-interest debt like credit cards and the rest to the emergency fund
  • More than 6x and <12x: divert most of the surplus to high-interest debt like credit cards and the rest to the emergency fund. If credit card debt is not there, then some surplus can be diverted to short-term goals (<5 years away)

Consolidating the result

Question Answer
Specific: Why do you need the money? To act as a cushion in case of emergencies
Measurable: How much money do you need? 6 times mandatory expenses and EMI
Achievable: Can you do it? Do you need help? Target 3 times expenses in 6 months, 6x in a year
Realistic: Can you reach this target based on where you are? All investible surplus must be diverted for creating this fund
Time-bound: When do you need the money? Is the timing flexible? Flexble but should be completed at the earliest

Where to save the emergency fund

We repeat our previous guide on where to keep your emergency fund below:

The emergency fund needs to be liquid, i.e. immediately available. Apart from household cash, bank accounts offer the next best place, followed by liquid mutual funds. Do not chase returns here and lock up this money in a way it is not available.

For banks, you can go with large banks like SBI, HDFC or ICICI (due to their SIFI status) and look for banks that offer sweep FDs. If your bank does not provide sweep FD, it is okay - keep some money in a savings account and some in FD. Make this a joint account with all adult family members and have multiple debit cards. At all times, look for good ATM coverage for your bank and have Netbanking via apps set up on your phone. Avoid banks that have been in the news lately for issues with their operations or have a recurring history of trouble.

After choosing a bank account, liquid mutual funds can be used (choose those liquid MF which invest in 91day T-Bills and cash only). If you cannot determine which funds have this feature, please stick to banks.

A high-limit credit card can be used as a part of an emergency fund if you have the money to pay it off and use it in an emergency. However, sometimes hospitals or medical stores may not accept credit cards, so this should not be your first choice.

Do not keep family gold, stock/equity MF etc., as an emergency fund - these are not liquid and can lead to losses if sold in a down market. These are for long-term emergencies like medical treatment etc., where everything needs to be spent.

Many people choose housing loans or overdraft accounts like SBI Maxgain etc., for an emergency fund. However, please don’t do this since the lender may change withdrawal terms, or it is difficult to take out the money in an emergency. Only the EMI part of the fund should be stored here.

Ultimately it would help if you wished that you never have to use your emergency fund but will be relieved to know it is there.

What's next? You can join the Arthgyaan WhatsApp community

You can stay updated on our latest content and learn about our webinars. Our community is fully private so that no one, other than the admin, can see your name or number. Also, we will not spam you.

To understand how this article can help you:

If you have a comment or question about this article

The following button will open a form with the link of this page populated for context:

If you liked this article, please leave us a rating

The following button will take you to Trustpilot:

Discover an article from the archives

Previous and next articles:

<p>A child’s education goal is the dream of every parent. We examine various return scenarios to see how much corpus you can create with a reasonable SIP amount.</p>
Children
How much can you save for a college education goal with a 10000/month SIP

A child’s education goal is the dream of every parent. We examine various return scenarios to see how much corpus you can create with a reasonable SIP amount.

Published: 2 October 2022

4 MIN READ


<p>This article shows how much you can withdraw from an equity mutual fund if you have a pension plan as well in retirement.</p>
Retirement Pension Safe Withdrawal Rate
How to mix an SWP from an equity mutual fund with a pension plan in retirement?

This article shows how much you can withdraw from an equity mutual fund if you have a pension plan as well in retirement.

Published: 9 October 2022

7 MIN READ


Latest articles:

<p>This article provides a clear guide to navigating the insurance requirements when securing a home loan, helping you make informed decisions.</p>
House Purchase Loans Insurance
Understanding Insurance Requirements for Home Loans in India: What's Mandatory and What's Optional?

This article provides a clear guide to navigating the insurance requirements when securing a home loan, helping you make informed decisions.

Published: 15 May 2024

3 MIN READ


<p>This article discusses the steps for investors in high-income brackets but hesitant to commit to a home loan due to the fear of job instability.</p>
Behaviour House Purchase Loans
How to manage a home loan if you are worried about job loss?

This article discusses the steps for investors in high-income brackets but hesitant to commit to a home loan due to the fear of job instability.

Published: 14 May 2024

8 MIN READ


Topics you will like:

Asset Allocation (21) Basics (8) Behaviour (13) Budgeting (12) Calculator (25) Case Study (6) Children (17) Choosing Investments (40) FAQ (12) FIRE (13) Gold (22) Health Insurance (5) House Purchase (33) Insurance (17) International Investing (12) Life Stages (2) Loans (20) Market Data (8) Market Movements (17) Mutual Funds (47) NPS (8) NRI (19) News (18) Pension (8) Portfolio Construction (53) Portfolio Review (27) Reader Questions (8) Real Estate (7) Research (5) Retirement (38) Review (16) Risk (6) Safe Withdrawal Rate (5) Set Goals (28) Step by step (15) Tax (59)

Next steps:

1. Email me with any questions.

2. Use our goal-based investing template to prepare a financial plan for yourself.

Don't forget to share this article on WhatsApp or Twitter or post this to Facebook.

Discuss this post with us via Facebook or get regular bite-sized updates on Twitter.

More posts...

Disclaimer: Content on this site is for educational purpose only and is not financial advice. Nothing on this site should be construed as an offer or recommendation to buy/sell any financial product or service. Please consult a registered investment advisor before making any investments.

This post titled SMART goals: how to create an emergency fund first appeared on 05 Oct 2022 at https://arthgyaan.com


We are currently at 401 posts and growing fast. Search this site:
Copyright © 2021-2024 Arthgyaan.com. All rights reserved.