By Hemanth Gorur
Lightning may not strike twice at the same place, but it certainly strikes at some point. Emergencies, similarly, are a part and parcel of life. Thus, emergency corpus is a mandatory component of one’s financial planning. However, what is troublesome is the uncertainty as to the timing of the emergency and the amount that may be required to deal with the emergency.
There are two approaches to determine the amount required. The first approach is to base the amount required on the salary you earn. So the emergency corpus amount could be three to 12 months of salary. If you are a self-employed individual, you can base the amount required on your monthly expenses. This could be three to 12 months of household expenses.
The second approach is to estimate the nature of the emergency. If you are genetically predisposed to certain ailments or conditions, insurance may not always cover all cases. In such cases, find out the approximate expenses for the respective treatment.
Similarly, if you live in a natural disaster prone zone, or have a history of careless driving, or find constant job relocation a reality, you will need to estimate the approximate expenses for rebuilding, recovery from accidents, or relocation respectively.
Once you have estimated the amount required, your next step is to solve for the uncertainty of the timing. Since you cannot predict when an emergency may occur, the ideal way to deal with this uncertainty is to stagger the maturity dates of your payouts.
Since your monthly income can take care of any urgent expenses, your investments for emergency corpus can be staggered out so that they mature at intervals of three months. These can be put on auto-renew option so that, if not used towards an emergency, they can start earning returns again, while the next investment due to mature will become your emergency corpus.
Based on your estimate of the pattern of emergencies that are likely to unfold, you can even stagger the maturity payouts to once every six months instead of once every three months, so that you get better returns.
Let us say 40-year-old Sarayu is worried about unexpected situations. She realises that as she lives in a flood-prone zone, disaster can strike at any point in time.She also realises that a new Covid-19 variant could affect the health of her aged parents in the near future, but decides to create an emergency corpus instead of buying insurance. Finally, she wants to plan for an eyesight correction surgery that may be required in a few years.
Sarayu estimates the amounts for rebuilding, healthcare treatment, and surgery to be Rs 10 lakh, Rs 5 lakh, and Rs 1 lakh, respectively. She estimates the timing of these emergencies to be 2-6 months, 3-12 months, and four years onwards respectively.
The ideal way for Sarayu to build her emergency corpus would be as follows:
Invest Rs 10 lakh in liquid funds with maturity of 90 days, to be renewed thereafter every three months.
Invest Rs 5 lakh in ultra short duration funds with maturity of six months, to be renewed thereafter every six months.
Invest Rs 1 lakh in a conservative hybrid fund, redeemable any time after three years to avoid short term capital gains tax.
While building an emergency corpus, do not try to maximise returns on investment. Rather, try to optimise returns while maximising the availability of the corpus amount when required.
The writer is founder, Hermoneytalks.com