We hear about having an emergency corpus all the time. Financial planners incorporate the quantum of emergency corpus in each of their financial plans for their clients. Even if you are not working with a financial advisor & managing your money yourself, you must know the importance of having an emergency corpus.
The pandemic has taught us why it is necessary to keep certain portions of your assets in highly liquid form that could act as a cushion in tough times. With that being said, investors still commit mistakes when it comes to managing their emergency corpus. Here are 3 mistakes to strictly avoid while dealing with your emergency funds.
1) Grinding over returns
Even though we realise the importance of having an emergency corpus, we usually forget about its safety and keep on grinding over low returns generated on this corpus. Investors tend to ignore the reason why emergency corpus is created in the first place. It is created to provide stability in case things go south & not to earn higher returns.
I met an investor once who said he has invested his emergency corpus in blue-chip stocks as they are liquid in nature & he can always sell those in real time & get the money if emergency arises. This is an incorrect approach of looking at emergency corpus. If at all a pandemic-like situation were to come again, not only could there arise a need to use this emergency corpus, but also it would be down in value due to stock market correction.
We have discussed about the components of emergency corpus here:
The above article gives a clear picture on building an emergency corpus that finds the balance between safety and returns.
There is an alternative way of using your emergency corpus to earn better returns without taking risks. Let's take for example you need an emergency corpus of Rs. 15,00,000.
We have discussed about calculating the emergency corpus here:
These Rs. 15,00,000 can be parked in a Low duration or Ultra short term fund & the interest accumulated on these funds can be shifted to an equity fund on monthly or quarterly basis to earn higher returns on equity portion in long-term.
Here is a table showing the calculation of how above strategy can work:
|Year||Debt Fund Value at the beginning of year||Transfer to Equity every year||Equity Value at the beginning of year||Equity Value at the end of year||Total Value at the end of year (Debt+Equity)||IRR|
|1||₹ 15,00,000||₹ 73,334||₹ 0||₹ 77,285||₹ 15,77,285||5.15%|
|2||₹ 15,00,000||₹ 73,334||₹ 77,285||₹ 1,63,844||₹ 16,63,844||5.32%|
|3||₹ 15,00,000||₹ 73,334||₹ 1,63,844||₹ 2,60,791||₹ 17,60,791||5.49%|
|4||₹ 15,00,000||₹ 73,334||₹ 2,60,791||₹ 3,69,371||₹ 18,69,371||5.66%|
|5||₹ 15,00,000||₹ 73,334||₹ 3,69,371||₹ 4,90,980||₹ 19,90,980||5.83%|
|6||₹ 15,00,000||₹ 73,334||₹ 4,90,980||₹ 6,27,183||₹ 21,27,183||6.00%|
|7||₹ 15,00,000||₹ 73,334||₹ 6,27,183||₹ 7,79,730||₹ 22,79,730||6.16%|
|8||₹ 15,00,000||₹ 73,334||₹ 7,79,730||₹ 9,50,583||₹ 24,50,583||6.33%|
|9||₹ 15,00,000||₹ 73,334||₹ 9,50,583||₹ 11,41,938||₹ 26,41,938||6.49%|
|10||₹ 15,00,000||₹ 73,334||₹ 11,41,938||₹ 13,56,256||₹ 28,56,256||6.65%|
As you can see, returns are optimised from 5% per annum to 6.65% per annum without taking risk on the base emergency corpus.
2) Using emergency corpus at will
The term "Emergency" in financial planning means a situation that arises in an unexpected manner impacting the financial position of a family. This situation can be either in the form of Job loss or medical emergency. We have already covered the importance of having medical/health insurance in place to ensure you don't have to dip into your emergency corpus to pay your medical bills.
Health insurance is a protection not only for your health but also for your wealth. It could be possible that your health insurance is insufficient to cover the entire bill & in that case you have to use emergency funds to pay the shortfall.
However, a lot of people do have emergency corpus but the same is used to buy gadgets, bikes & things that have nothing to do with emergency. Also in cases where a person has kept aside the emergency corpus for a long time without using it has a general tendency to play with it as he thinks that emergency won't arise. This attitude can lead to severe consequences.
Keep in mind that emergency corpus is created for EMERGENCY purposes. If you haven't faced any emergency situation in the past, that doesn't guarantee an emergency that may arise in future. It could be possible that your corpus goes untouched for many years but that should not be the reason to play around with it.
3) Not evaluating your emergency corpus on regular basis
We go through various stages in life. Each stage brings new responsibilities. Imagine the difference between a young guy who just landed a job and started earning and another guy who has taken out a home loan after getting married. Both of these folks will have different sets of requirements when it comes to emergency corpus.
A person who has just started working can have 6 months worth of his expenses parked for emergency purposes but a person who has taken a home loan has to re-evaluate his need for emergency corpus and increase it by adding the monthly EMI amount to the corpus. Keeping a static amount as emergency fund for longer duration can be tricky as it might not be sufficient in case the emergency were to arise. Re-evaluate the need for emergency corpus at periodic intervals based on events in your life & make the necessary provisions.
It is always prudent to keep more than less in an emergency corpus. Nobody ever complained about having more in emergency corpus as it gives peace of mind & stability.
CA Rohit J. Gyanchandani is Managing Director, Nandi Nivesh Private Limited, A Pune based Wealth Management Company.
Follow the entire series on Emergency Funds here.