Rs 50k salary: 6-month emergency fund means Rs 3L?

Keep a 6-month emergency fund ready; you've probably heard this. But how should you calculate the ideal emergency fund amount? For someone earning a Rs 50,000 monthly salary, does a 6-month emergency fund mean having Rs 3 lakh? Or should they aim to amass 6 months of expenses?

That's where many people get the calculation wrong. Charu Pahuja CFP, Director and COO, Wise FinServ, tells ET Wealth Online that one should go by expenses and not the salary to calculate the ideal 6-month emergency fund.

Let's say someone takes home Rs 50,000 every month but needs only Rs 30,000 to manage rent, groceries, electricity, transport, insurance and other unavoidable expenses. Why should they necessarily keep Rs 3 lakh aside when their basic expenses for 6 months would be much less?

Emergency fund should always be weighed in terms of the total household expenses, which is a sum of regular and one time / irregular expenses like premiums, festival-related expenses or any other one-time payments.

Arti Arora, Senior Vice President, Bajaj Capital, says this ensures that irregular, but predictable expenses are accounted for when determining the reserve required to protect the household financially. Follow these steps to get started on your journey to create a 6-month emergency fund:

1- Calculate regular monthly expenses: Rent or home loan payments, groceries, utilities, school fees, transport, healthcare and other recurring household costs.

2- Add irregular and one-time expenses: Annual insurance premiums, festival-related spending, annual school expenses, maintenance costs and other periodic payments.

3- Amortise these expenses monthly: Add up the regular expenses and the annual equivalent of irregular expenses.

4- Build a six-month reserve: Multiply the resulting average monthly expenditure by 6 to establish an emergency fund target.

So, if someone’s monthly expenses are Rs 30,000 on a Rs 50,000 salary, they should aim for a 6-month emergency fund of Rs 1,80,000.

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Should you aim for 6 months, or better to start with a 3-month fund?

Pahuja opines, “For someone who has just started earning, even getting the first month's expenses into a separate account is progress. From there, three months is a good initial target. Six months can come later.”

Keep in mind that the number will change depending on the circumstances. Someone with a stable job and few financial commitments may be reasonably comfortable with 3-6 months. “I would prefer a larger reserve for someone working on contractual assignments, earning irregular incentives or supporting the household alone,” she says.

While calculating the amount, you should count everything that still needs to be paid even when salary stops. Account for expenses like rent, school fees, groceries, utilities, insurance premiums and loan EMIs. If an annual health insurance premium is Rs 24,000, include Rs 2,000 a month in the calculation, Pahuja said.

How much to save every month?

The starting point of building up the emergency fund reserve emanates from discretionary cash flow available to an individual after their regular household expenses. Arora suggests one could start with 5-10% of their salary and build up the fund reserve comfortably.

For someone earning Rs 50,000/month and spending Rs 40,000/month, one can build a 3-month reserve in 2 years with 10% of salary allocation. It can be built up faster with allocation from bonuses or any other liquid savings.

An individual having a monthly spending of around Rs 30,000 should try to save Rs 5,000 to Rs 10,000, given the budget permits it, according to Pahuja. Here’s how the numbers work:

(Source: Charu Pahuja CFP, Director& COO, Wise FinServ)

Note: Calculations exclude interest earned and assume savings start from zero.

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Where to keep your emergency fund?

Pahuja says, “I wouldn't invest this money in stocks or equity mutual funds. Imagine needing cash for a medical emergency when the market has fallen sharply. That is not the time you want to be selling your investments.”

She instead prefers keeping the first month's expenses in a savings account. The rest can be spread across bank FDs with premature withdrawal facilities and, where suitable, liquid mutual funds or overnight mutual funds.

“One should remember that liquid funds are not the same as bank deposits, and their returns are not guaranteed. Under normal circumstances, redemption proceeds are generally credited on a T+1 working-day basis,” Pahuja explained.

However, investors may not always have to wait until the next day. Some AMCs offer an instant redemption facility in select liquid and overnight funds. The purpose here isn't to earn an impressive return. It's to make sure the money is available when life doesn't go according to plan.

Emergency fund or SIPs: What should young earners do first?

Every first-time earner could get confused between these. So, what should they aim for first?

An emergency fund is the foundation of any sound financial plan. For someone early in their career, Arora recommends prioritising the creation of an emergency fund before taking on significant investment commitments. However, it need not always be an either-or decision.

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If income is stable, expenses are manageable, and there is room for savings, Arora says one can pursue both. For instance, allocate 50% of monthly savings to the emergency fund and the remaining 50% towards SIPs.

Prioritise emergency fund over SIPs

Pahuja underlines that a young investor shouldn’t stop thinking about SIPs until they have saved 6 months of expenses. That could mean losing 2-3 years of investing, sometimes even longer.
“My preference is to first accumulate roughly one month of essential expenses. After that, the person can do both

Suppose someone has Rs 10,000 available every month. They could put Rs 8,000 towards emergency savings and Rs 2,000 into an equity SIP for long-term goals, assuming there is no expensive outstanding debt.

Emergency fund calculation: Person with dependents vs without

An individual who is single and has no dependents may not need the same amount of emergency fund as someone with a family. Typically, 3–6 months of essential living expenses is a reasonable target for a single individual, Arora explains. However, if the individual's parents are financially dependent on them, the emergency fund should be increased.

In this case, where parents are dependent, 6–12 months of essential household expenses will be more appropriate, depending on the parents' health, medical needs, and other sources of income.

Pahuja explains this with an illustration.

Take two people, both earning Rs 50,000. One lives independently and has no major responsibilities. The other supports retired parents, pays household bills and takes care of their medical expenses. For the first person, 3 to 6 months of expenses may be enough. For someone supporting parents or running the household on a single income, the emergency fund should have at least 6-9 months' expenses.

(Source: Charu Pahuja CFP, Director& COO, Wise FinServ)

Used Rs 60,000 from emergency fund: How quickly should you replenish it?

It depends on why the money was withdrawn and how much is still left. If someone had to pay an unexpected hospital bill, there is nothing wrong with using the emergency fund. But if they are regularly taking money out to clear credit card dues after overspending, they should review their spending habits.

For someone looking to replace Rs 60,000, the calculation is simple:

Pahuja advises trying to restore the amount within 1-12 months if the budget allows.

Salary: Rs 50,000; monthly spend Rs 30,000; savings Rs 5,000: How to build Rs 1.80 lakh faster?

If the individual starts from zero, Rs 5,000 every month will take 36 months to become Rs 1.80 lakh, excluding interest. Three years may seem long. But they don't have to wait 3 years to benefit from their savings.

After 6 months: Rs 30,000, enough for one month of essential expenses.

After 18 months: Rs 90,000, which can cover three months.

After 36 months: the full six-month reserve is available.

The Rs 1.8 lakh emergency fund target can be achieved sooner if the savings amount is increased:

(Source: Charu Pahuja CFP, Director& COO, Wise FinServ)

Someone able to save just Rs 5000/month with Rs 30,000 household expenses can also target a Rs 90,000 emergency fund (for 3 months) initially. Arti Arora suggests that they start a monthly RD of Rs 3000 and set up a SIP of Rs 2000 in a liquid fund.

Assuming no existing emergency fund and ignoring investment returns, it would take 18 months to build a Rs 90,000 reserve. After building a 3-month expenses-equivalent emergency fund reserve, one can consider exploring arbitrage funds and other growth avenues for tax-optimised returns.

Moreover, you must revisit the calculation whenever living expenses rise. If essential spending increases from Rs 30,000 to Rs 33,000, the six-month requirement becomes Rs 1.98 lakh.