How Much Should I Put In My Emergency Fund Every Month?

“I am a salaried individual with a monthly income of Rs. 1 lakh and expenses of around Rs. 70,000 every month. Currently, I have savings of around Rs. 3 lakh in my bank account for emergencies. Is this enough, or do I need a larger emergency fund? If yes, how much should I save every month to create a sufficiently large Emergency Fund?” – Ritika.  

An emergency fund is created to manage unforeseen financial needs such as those arising from job loss or salary cuts, medical emergencies not covered by insurance, unexpected travel expenses, etc. 

To determine how much you need to save every month in your Emergency Fund, you first need to calculate the ideal size of the fund. It is generally recommended that the size of an Emergency Fund is substantial enough to cover monthly expenses for a period of 6 to 9 months. 

As your monthly expenses are Rs. 70,000, your Emergency Fund needs to be between Rs. 4.2 lakh and Rs. 6.3 lakh. To be on the safe side, you need to consider creating an Emergency Fund for the higher amount of Rs. 6.3 lakh. Since you already have savings of Rs. 3 lakh in your bank account, you need to save an additional Rs. 3.3 lakh.

One option could be to park your bonus or matured bank fixed deposit, if any, towards your emergency fund. The other option could be you can start saving monthly for it.  

Since your monthly savings are around Rs. 30,000, assuming you can save around 50% of it towards the emergency fund, it will take you around 2 more years to save an additional Rs. 3.3 lakh, if you start right now. This is assuming that no unexpected expenses come up.  

Now you need to find out options to park your monthly savings for an emergency fund. Since your emergency funds need to be invested in minimal risk instruments, you have 3 options – your savings account, starting a bank recurring deposit (RD), or starting a SIP in a Debt Mutual Fund such as an Ultra Short Duration Fund.  

If you choose to use your bank savings account to maintain emergency funds, you need to ensure that you are disciplined enough not to withdraw and spend your money except in the case of an emergency. This is difficult to do unless you have a different bank account to park your emergency funds. On the other hand, using a bank recurring deposit (RD) to save emergency funds will give you slightly higher returns around 3.5% p.a. However, if you withdraw your recurring deposit investments prematurely you will have to pay a penalty, which can decrease your overall returns from the investment. Plus, the interest from Bank RDs is fully taxable as per your income tax slab rate. 

The other investment option that you can consider is Debt Mutual Funds such as Ultra Short Duration Funds. These funds generally offer returns slightly higher than bank RDs plus if you hold the investments for more than three years, you have a tax advantage when compared to bank RDs. Long-term capital gains get taxed at 20% plus indexation while the interest earned from RDs is fully taxable. Indexation benefits adjust the price of purchasing mutual funds units upwards by the inflation rate, thus reducing the tax liability. Moreover, these Debt Funds are highly liquid, which ensures that you can easily access your funds in an emergency without paying any penalties.  You can opt for regular investments in these Debt Funds via a monthly Systematic Investment Plan (SIP) to reach your Emergency Fund investment goal. However, do remember that returns from debt funds are not guaranteed like bank RDs.