Emergency fund: A weapon that can help you fight financial vulnerabilities
The most potent weapon is the margin of safety or buffer of emergency funds, built in the good times.
The boy ran up and down the stairs. Suddenly, he lost his balance and fell, shrieking in pain. His mother, who was working nearby, came running. When she realised he had a fracture, she screamed in rage and then broke into tears. The boy was hoping to be comforted, but got only fury. Most of us can’t deal with the anxiety of unexpected expenses. Our financial vulnerability is exposed in our responses to such situations.
The mother does care for the boy. Her response was her helplessness in the face of an expense she could ill afford. I recall childhood days when the mood at home grew sombre as the end of the month approached. We would have mostly run out of money, and as pay day approached, we would hope that nothing untoward happened. Even a wedding invite was unwelcome!
Whether we have a comfortable financial situation or not can be measured by how we deal with the unexpected. Not just a medical emergency or job loss, but even simpler events like a cancelled flight that needs rebooking; a delayed travel that requires hiring a car; a reworked dinner plan that means a bigger bill; a changed preference for a more expensive jewellery while shopping for a gift; or a shopper’s dilemma of liking more dresses than one set out to buy.
Many of these sound trivial and simple. But ask a household about the emotional and psychological impact these decisions have on their life and there will be interesting stories. The family will sulk at the idea of fighting with the right hand side of the menu card, choosing and scratching off meal choices, to a point where the dining out experience loses its joy. It is not about being miserly or generous; it is just the inability to allow the family to choose whatever they wished. The need to control stems from the anxiety about the expense, exposing financial vulnerability.
Stable and rising income is the first cure to the problem. In the last 28 years since liberalisation, we have seen signs of better financial health around us, evident in confident spending by many households. There aren’t many middle class households like the one I lived in as a child. Even those who face a shortage see it as a temporary problem and are confident of swiping their credit cards, treating it as a liquidity blip. The young mother in the story earned an income that was insufficient for her household. If her alcoholic husband also went to work, she would have been better off.
Managing a low level of indebtedness is another weapon to deal with unexpected expenses. Families with too many EMIs to pay, credit card debt to clear and personal loans to return are vulnerable. They brought it upon themselves, by indulging in expenses and loans that took away a chunk of their income. The security that a stable, high and rising income provides is reduced by loans. Households do not see this trade off clearly. The confidence in income leads to piling up of debt. Soon, there is too little to go around and unexpected expenses rock the boat.
Support systems and networks one builds over time offer an important cushion to deal with the unexpected. The young mother was supported by her employers who offered help to get the boy hospitalised, offering much relief. She had a low income, but her employers in whose houses she worked offered her a safety net. Friends, relatives, and colleagues are the first port of call when unexpected expenses strike. However, overusing this network can lead to it breaking off. People turn their back on habitual borrowers.
The most potent weapon is the margin of safety or the buffer of emergency funds, built during the good times. Financial planners emphasize that at least six month’s worth of income or 12 months of mandatory expenses of a household is saved in a ready to access investment like a bank deposit or liquid fund. This emergency fund offers a ready and honourable fall back option.
When you observe people for their financial anxieties and their behaviors in the light of unexpected expenses, you notice the two features of being moneyed—the ability to spend; and the willingness to spend. The first one is the mark of financial strength. Those who argue that money is not important do not know the anxiety, helplessness, and fear caused by not having enough money when an unexpected situation presents itself. The security and satisfaction arising from having enough, so one is able to calmly face life’s various challenges, is a worthwhile financial goal to pursue.
The second one, namely the willingness to spend is about the attitude towards money. Some of the richest amongst us are also the most miserly. They fail to utilise the security and strength that their money offers them. They fear losing what they have, and refuse to part with money, even for dire and important needs. Unwillingness to use money is a psychological problem that no amount of accumulated wealth can address.
When financial advisers look at a household and assess its financial position and ability to take risks, they run a series of questions. Some of these questionnaires are also available online. It is important to know that measuring ability is fact-based; measuring willingness is more nuanced.
Making the household secure against the unexpected expense is a tough literal goal – you cannot provide for what is unknown or unexpected. But building wealth, ensuring a buffer, stabilising the incomes, creating an emergency fund, keeping loans low, and ensuring adequate insurance are all achievable financial goals that reduce the financial vulnerability of the household.
Necessary paperwork to enable access and use is equally critical. Never forget that minor children, elderly parents, special children, financially illiterate spouses, dependent kin, are all more financially vulnerable. Ensuring access, correct application and use is as important as providing funds for them.
(The writer is Chairperson, Centre for Investment Education and Learning)