Your Emergency Fund Number Isn’t One-Size-Fits-All – Here’s Why

Everyone is told to set aside six months’ worth of expenses in an emergency fund. It is a simple rule, easy to remember and follow. But it overlooks one important factor: not everyone faces the same level of financial risk.

A more realistic approach to building an emergency fund takes three things into account: how long it might take to replace lost income, how much money is needed to cover essential expenses, and what costs may not be covered by insurance.

Start With Income Replacement

Someone with five years of experience in the software industry, for instance, may not take long to find another job. The person who has 25 years of experience as a senior executive may spend a long time looking for a suitable job. The amount of money he or she may earn will depend on his or her past experiences.

“The people who work in industries, such as IT services, banking, and manufacturing should plan accordingly and save enough money which can be used to fulfil their basic requirements for nine months to one year,” says Akshay Gulati, founder, SuperInvesting.ai, an AI-based investing research platform.

It becomes difficult for people who have their own business, as sometimes, a bad business cycle may cause trouble for them.

Calculate Essential Expenses, Not Lifestyle Spending

The next step is determining what your family will need to spend once your income ceases. Your weekend meals, holidays, and any non-essentials could be trimmed down. However, your mortgage repayments, food expenditure, tuition fees, insurance payments, and medicines required by a parent cannot.

For a household which spends Rs 1.20 lakh a month, reducing their expenses to Rs 70,000 should be possible. An emergency fund based on essential expenditures rather than total expenditures may help avoid accumulating unnecessary amounts of money.

“Nevertheless, the contractual commitments, education, and any dependents need to be taken into consideration. The intention is to keep liquid assets without accumulating unnecessary funds,” says Gulati.

Account For Insurance Gaps

An emergency fund should be used in tandem with insurance, but not instead of it. With adequate health coverage, people can avoid having large medical bills, and relying on group coverage offered by one’s employer leaves the family without any coverage if the employment is terminated.

The purchase of health coverage at a later time could come with underwriting, waiting period, or exclusions. It is important to know all of this in advance. In case there are large medical bills, that will not be covered by any other means. The emergency fund must have an extra medical cushion built into it.

Three Households, Three Different Numbers

Let us consider three examples to illustrate the point.

Rohan, 29, works as a product manager in Bengaluru. He is unmarried and debt-free, and has personal health insurance in addition to the cover provided by his employer. If his essential monthly expenses are Rs 40,000 and he expects to take about three months to find a new job, Rs 1.20 lakh would be a reasonable starting point for his emergency fund.

Sharma, 47 years old, is a deputy general manager working in a public sector bank located in Lucknow. He has a wife who is a teacher in a school, their child is in Class 10, and his parents have health insurance of their own. With essential monthly expenses of Rs 60,000, an emergency fund covering four months would amount to Rs 2.40 lakh.

Mehta, age 52, is into the business of trading auto parts in Ludhiana. He earns for himself, his son is in a private engineering college and his father is on dialysis. His essential expenses work out to Rs 1.10 lakh per month and 12 months will amount to Rs 13.20 lakh before any contingency for health.

Keep It Accessible and Review It Regularly

Have one month's worth of necessary expenditures in savings or sweep-in fixed deposit (FD) accounts. The rest can be invested in appropriate liquid investments, such as liquid funds or short-term FDs, depending on timelines and terms of withdrawal.

Adds Gulati: “Do not use stocks or real estate as your main source of emergency funds. Stocks may fall just as you lose your job, and real estate may take months to sell. Credit cards are loans; they cannot be your emergency fund.”

Assess your required emergency fund annually or after a significant life event, such as wedding, your child starting college, taking on a new mortgage, and so on.

The bottom line is that the size of your emergency fund should depend on your actual needs rather than an arbitrary savings target. While six months’ worth of expenses may work well for you, the right amount is ultimately what gives you adequate financial security.