Emergency fund

Every other goal in a financial plan can wait a year. This one cannot.

The emergency fund exists for the month the salary does not arrive — a job loss, a business going quiet, an illness that stops work. Without it the household has only two options, and both are expensive: sell long-term investments at whatever price the market happens to be offering, or borrow at credit-card rates.

The workbook is unusually blunt about its priority. An emergency fund is the first goal towards which a household or individual should save, ahead of retirement, ahead of the child's education, ahead of the house.

Three rules define it, and each one is examinable.

Size. The fund should be adequate to meet expenses for six months in the event that regular income is not available. Note what is being counted — expenses, not income. A household earning Rs 2 lakh a month but spending Rs 1.1 lakh needs six months of Rs 1.1 lakh.

Where it sits. In liquid assets, to enable easy access as and when required. Where income security is high, the workbook permits a laddered structure instead: roughly three months' expenses in liquid assets, and the remainder in less liquid assets that give a better return.

Maintenance. If the fund is used, efforts must be made to replenish it as soon as possible. Its adequacy should be reviewed annually, or whenever there is a large addition to monthly expenses — such as a new EMI.

The Nairs: combined take-home of Rs 1,85,000 a month, both salaried, in stable jobs.

Target emergency fund = 1,14,000 x 6 = Rs 6,84,000.

Because both earn and neither job is at risk, they may ladder it as the workbook allows:

Now the annual review bites. In April they take a car loan with an EMI of Rs 21,000. Monthly expenses rise to Rs 1,35,000, so the required fund rises to Rs 8,10,000 — a top-up of Rs 1,26,000 that has to be found before any surplus goes towards the equity SIP.

That is the whole discipline in one line: the EMI did not merely consume Rs 21,000 a month of cash flow, it silently raised the reserve requirement by Rs 1.26 lakh.

Chapter 3 (Cash Flow Management and Budgeting), section 3.8 on contingency planning, where the emergency fund sits alongside life insurance, medical insurance and the risks of a single income. The recurring questions are numerical — six months of expenses, not income — and conceptual: which goal comes first, and what triggers a review of the fund's adequacy.

• Six months of expenses, not six months of income. Questions deliberately give you both figures. The larger number is the distractor.
• Three months is the laddered tranche, not the target. The workbook permits holding about three months in liquid assets and the rest elsewhere — only where income security is high. The total stays at six months.
• The emergency fund is the first goal, not a residual. It is not what is left after the SIPs; the SIPs are what is left after it.
• A new EMI triggers a review. So does any large permanent addition to monthly expenses. An annual review is the floor, not the whole rule.
• Replenishment is part of the rule. A fund that was drawn down and never rebuilt is not an emergency fund.
• Do not confuse it with insurance. Insurance transfers a specific, large risk; the emergency fund absorbs a general, temporary loss of income. The workbook lists both, separately.