Do It Yourself: How to calculate emergency or contingency fund?
If we look at the number of people that have made provision for any emergencies then every 3 out of 5 people have made provision less than Rs. 5,000. This shows the amount of unawareness about emergency fund. It is really important to have an emergency fund at first place even before planning for any other needs or goals or even taking up insurance. Emergency fund is the provision for events such as job loss or loss of income for a short span of time. You can say that emergency fund is kind of a self-insurance wherein you are insured against any loss of income in the short-term.
So now let’s get started with the calculation. There are two ways in which you can calculate emergency fund, viz. income method and expense method.
Income method
This is one of the simplest methods of deriving your emergency fund. To calculate it, apply rule 3/6/9. This means that you just need to take your monthly income and multiply it by the 3 or 6 or 9 based on scenarios. Here, 3, 6 and 9 means months. If you are currently single or have recently got a job then consider 3 multiplied your monthly income as your emergency fund. If you are a couple with or without children then consider 6 multiplied by your monthly income as your emergency fund. Finally, if your income or even your spouse’s income is variable in nature, then consider your or your spouse’s average monthly income and multiply it by 9.
Expense method
Calculating emergency fund based on expense method is the same as the income method where we applied 3/6/9 rule. Only the difference is that in income method we took monthly income, here we will take monthly expense. Now you may think that, why anyone would go with the expense method. Expense method actually gives you precise requirement of your emergency fund. In the case of income method, you are considering all the expenses including the lifestyle expenses such as dining out, watching a movie or an event, spending on parties, etc. However, in case of emergencies, it is assumed that you won’t be incurring such discretionary expenses. So, the expense method helps you to eliminate such expenses.