26 Jun 2007 | Comments | Wealth Management | Comments feed

How Much is Adequate for Emergency Fund

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Emergency fund is the amount of liquid money set aside for unexpected circumstances. According to Golbguru, the emergency fund must adhere to the following three requirements:

1. Must be liquid and easily accessible through common instruments like cash or checks.
2. There should be a sufficient margin of safety built into it
3. It should be held as risk free as possible.

Golbguru also defined that your ideal emergency fund should be able to cushion the worst possible scenario (specific to your personal situation) that you can imagine. Add a 20% margin of error to that estimate and aim for that emergency amount.

The most interesting part in the post is this risk vs emergency funds graph:

I totally agree with the concept voiced out here. If you are putting more money at low risk and liquid account, you are actually building an emergency fund out of that practice. In other words, if you are investing most of your money, you probably increase the risk to get better return, hence reducing the liquid part of your portfolio. So the question now is do you separate your emergency fund account when you plan your investment portfolio?

Here are my opinions about this matter which also represent my practice:

1. I don’t separate them. I see the emergency fund as a low risk portion of my investment portfolio.

2. To me, liquid account is easily accessible account which can be cashed out within 30-50 days. Why 30-50 days? Isn’t it too long? No, I don’t think that it is a long duration because I have several credit cards with enough limit to be used as buffer. Nowadays, you can pay almost everything with credit card except the debt itself. If the account can be liquidated within 30-50 days, it is soon enough to pay the credit card on due date.

3. Liquid accounts to me include unit trust (mutual fund), bank accounts, flexible home loan accounts, fixed deposit, and even shares. According to my past experience, not every share counter I hold are having loss at the same time, provided that the share portfolio is properly diversified. When it comes the time you need to sell off some of the share for emergency purpose, the main concern should be which stocks are appropriate to be sold: the losing ones or the gaining ones?

4. Is insurance considered for emergency? Yes and no. Without insurance, there is no use for the emergency fund. It is just wasting your money if you put it into an emergency account but not insuring the most valuable assets you own, including your own life. Yes, insurance will act as an emergency if you have medical card for hospitalization, or in the event of dreadful disaster where insurance is claimable. But the answer is NO if you are facing emergency situation where insurance doesn’t cover the event such as unemployment. The fact is not everything in life is insurable.

5. It is better to control or avoid the risk of depending on emergency fund. If you are employed, or actively involved in some business activities that will cease providing incomes at the time you stop working, emergency funds are so important to you. You might need a substantial amount. That’s why it is so important to work on getting passive income. Regardless of whether you have the emergency fund or not, when disaster come unexpected and not covered under insurance, it will still eat into your net worth. Better to avoid it and minimize the risk rather than setting aside money to prepare for it.

For further information discussion about emergency fund, you can visit:
Money Question - Can You Save Too Much in an Emergency Fund?
How Much Emergency Fund Is Too Much Emergency Fund?

My other related articles:
8 Questions Financial Health Check

Technorati Tags: emergency fund, adequate fund, liquid account

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