Lesson 5 of 6, 4 minutes
The emergency reserve
Money that keeps a bad month from changing your plan.
The car needs a new clutch in the same month that your laptop stops working. Neither one is a disaster. Together they cost more than the month has room for, and the money has to come from somewhere.
Without money set aside, it comes from one of two places. You sell investments, possibly in a month when prices are down, and you give up the years of growth those investments had ahead of them. Or you borrow on a credit card and pay interest that is usually higher than what your investments earn. An emergency reserve is a third place. It exists so that a bad month stays a bad month and doesn't become a change to your plan.
How much
Size it in months of spending. Income is what stops in the emergencies that matter most, such as losing a job or being unable to work, and what you need then is time.
| 3 months | ₹2.40 L |
|---|---|
| 6 months | ₹4.80 L |
| 12 months | ₹9.60 L |
One month of spending in this example is ₹80,000.
Six months is a common starting point. Hold more if your income is irregular, if your household depends on one salary, or if people depend on you. Hold less only if you have another source you are certain of.
Where to keep it
The reserve has two requirements. You must be able to reach it within a day or two, and its value must not fall in the week you need it. Shares fail the second test. So does anything with a lock-in or a penalty for leaving early. The return on a reserve will be low, and that is the price of it being there.
It has to grow with prices
A reserve that covers six months today covers fewer months every year, because the months get more expensive. At 6% inflation, the six months that cost ₹4.80 L now will cost ₹15.39 L (₹4.80 L in today's money) in 20 years.
The calculator treats the reserve this way. It takes the reserve out of your corpus in the month you retire, raises it with inflation every month after that, and never spends it. In the scene it is the piggy bank, which turns pink on the day the fire is lit.
Do this week
- Work out six months of your spending. That is your target, and it goes in the calculator's emergency reserve field.
- Open a separate account for it. Money that sits in your everyday account gets spent on things that are not emergencies.
- Write down what counts as an emergency before you need one: lost income, a medical bill, a repair you can't postpone. A sale does not count.
- Once a year, raise the target by the year's inflation and top the account up.