The new normal: Emergency funds to cover six months of expenses not enough anymore say financial planners

• An emergency fund is a buffer that financial planners recommend to tide over with in case of a job loss or any other financial crisis.
• A higher emergency fund is what is being recommended after the pandemic and looking at the current job market scenario.
• A larger emergency fund is also required if you have commitments like a home loan or other EMIs.

The experience during the pandemic changed us in several ways. We realised the importance of health and health insurance and many of us went through financial difficulties either because of job loss or salary cuts. We also released the importance of an emergency fund.

An emergency fund provides a financial safety net, covering essential living expenses such as housing, utilities, and groceries in case of job loss or income reduction. This liquidity ensures that individuals can meet their immediate needs without resorting to high-interest debt or compromising long-term financial goals.

Moreover, an emergency fund provides a psychological buffer, alleviating stress and anxiety associated with financial instability.

Why do you need a larger emergency fund?

It is important to save for a rainy day but how much should one save? Normally financial planners have been recommending saving three to six months of one’s expenses in an emergency fund.

But post pandemic and especially in the times we live in now, experts are recommending to keep 12 months of expenses as an emergency fund.

“Before Covid we were looking at six months of your expenses as an emergency fund, now we are looking at 12 months,” says B. Srinivasan, director and founder, Shree Sidvin Investment Advisors.

The main reason is that today, the job market is extremely competitive. Generative AI can effortlessly imitate numerous white-collar positions that are routine responsibilities, according to Pearson research. Moreover, a Linkedin study has shown that eight in 10 Indians are looking for a job change in 2024.

Job losses, as seen in the IT sector, have also become more prevalent due to artificial intelligence increasingly automating a lot of jobs and making jobs redundant.

“The driving factors behind these anticipated layoffs include the need to reduce costs, the anticipation of an upcoming recession, the desire to increase profits, and the integration of AI, which is replacing some job functions,” says Kartik Narayan, CEO of Staffing Firm, TeamLease Services, a staffing solutions firm.

If you have a fairly stable job, your emergency savings can be slightly lower. But in some cases, you may require even up to two years of emergency funds, “Those that have started some enterprise with a gestation period can have up to 24 months of emergency funds,” says Suresh Sadagopan, Founder, Ladder7 Financial Advisories.

A larger emergency fund is also required if you have commitments like a home loan or other EMIs. So, it is important to factor in all these when you are calculating your monthly expenses.

The amount of emergency fund you need will also need to be higher if you have elderly members in the family who do not have adequate health insurance.

How to build an emergency fund

Building an emergency fund worth 12 months expenses can seem a daunting task, especially if you have not started yet.

“The rule is to divide the salary into one third and two-thirds. One third of income should be compulsorily saved and it should go towards building an emergency fund, it should not go towards long term savings.” says Srinivasan.

One may keep the emergency funds in their savings account. However, it is recommended to park it in liquid funds for a slightly higher return.