How do I know if my emergency fund is sufficient?

Expert answers questions on personal finance

By Dhaval Jasani/Money Matters

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Published: Tue 16 May 2023, 5:40 PM

How do I know if my emergency fund is sufficient? I have health insurance provided by my company, and personal health insurance for self and family? How much should I have as emergency fund at any given point in time? How much should I save/month on this? Ours is a family of four.

Apart from covering your family under health insurance cover, you should at least have reserves to the extent of six months of your monthly cash outflow that is to be used only in the case of emergency and not otherwise. In case used, the amount should be replenished at the earliest. To start with, if you can set aside 10 to 15 per cent of your monthly earnings as reserves over a period of one year, that would accumulate to 1.2 X your monthly earnings at 10 per cent saving or 1.8 X your monthly earnings at 15 per cent savings. Once you have built up a corpus that takes care of six to 12 months of your monthly cash outflows, surplus amount may be invested gradually, depending upon your risk appetite.

Assuming that you have two children, and they would be studying, you also need to start envisaging requirement for educational expenses when the kids opt for higher education. University fees are quite steep and require substantial amount of cash outflow at one go. Alternatively, you may wish to opt for an insurance plan for your Child’s education where you are able to contribute on a monthly or quarterly basis and the amount contributed could generate returns and cash flow for you at the time when you need to fund your children’s education in future.

If you are the only earning member in the family, you may also wish to opt for your life insurance, nominating your spouse as the beneficiary in the insurance policy, to insulate your family in case of any unforeseen event.

My wife wants to start a business and invest some of our savings - Dh200,000 in a small food business. Is it a good decision? The issue is, if we invest the Dh200,000 on her organic food business, we don’t have much cash in the bank. I have no loans.

It is a very encouraging move for your wife to commence this journey as an entrepreneur. We assume that both of you have done required due diligence in terms of market potential, purchases, sales, deliveries, competition, challenges in the business, strategies to mitigate these challenges and last but not the least, managing accounting and finance of the business.

At this stage, the two of you may spend some time to prepare a budget for this business. Once you have addressed these pertinent aspects and affirmed viability of this business, you may now wish to recalculate your investment horizon and downsize it to start with, considering limited amount of cash surplus, that is available at your disposal.

This move will enable to you hold some cash in the form of emergency fund at this juncture. For a start-up, the first six to twelve months are very crucial. In this time frame, based on the performance, you will be able to ascertain if this business is able to generate profits after recovering all operating costs, and review the actual performance vis a vis budget prepared earlier. After carrying out this reivew, you may wish to introduce more capital into the business if it is profit making.

And yes, if this business is profit making, you may also be able to invite a co-investor to fund the business for any expansion. In case the business is not able to generate profits as envisaged earlier, you may reconsider your decision. Investing most of your savings at one go may lead to dismal reserves that would be available at your disposal, which may not be a healthy sign. For any emergencies, you will end up borrowing funds that will have interest cost implication and fixed repayment obligation. Failure to honour this obligation will have a direct impact on your credit rating and future borrowing ability.

This option of borrowing will eventually add more stress to your cash flows. Hence, we would recommend that you downsize the initial capital requirement for the business and analyse performance over the next six to twelve months. By then, you will have a chance to increase your savings as well. We wish you and your wife the very best for this endeavour.

The writer is co-founder and CEO of ZTI Global

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