Aug 19, 2012

Your first savings

This article is intended as a guide to anyone and everyone, regardless of age, who has yet to start any savings.

Getting your finances in order is like constructing a building. First and foremost you need to ensure that the foundation on which it is built is strong, and only then do you build on it. Building a strong financial foundation means having enough cash for any and every eventuality. Only after you’ve created this foundation should you look to build any further.

Most people who don’t have any savings are prone to experience a cash crunch at some point of time. Having a strong financial foundation means having enough cash to tide over any cash crunch. We are not talking about those people whose expenses over-shoot their incomes. We are talking about those cash crunches that arise due to unforeseen situations like- a sudden medical expense, loss of employment, or any other sudden and necessary expenditure that needs to be taken care of immediately.

To tide over these exigencies we need to create an- ‘Emergency Fund’ for ourselves. What this fund will do is provide cash when we have an urgent requirement for it. This fund will provide for the smooth functioning of our lives even during times of financial pressure.

How much this fund should constitute is a subjective question, rather than an objective one, and will therefore differ from person to person. In most financial plans we look to build a corpus of around 6 months to one year living expense. That is we take the average monthly expense and build a corpus that is around 6 to 12 times that amount. The reader should be able to ascertain this amount for his/her self. 

Now the next question that comes is where to park this fund. For this fund the primary criteria is liquidity. That is you should be able cash this fund anytime you want to. Don’t look at any financial instruments with a lock-in period. Also don’t look at any instruments that have an exit-load that could affect your capital when you withdraw. Most tax-saving instruments don’t qualify on both those counts.

A bank savings account is one of the best places to park this fund. One could also look at building up this corpus through a recurring deposit in a bank. If the corpus is already created then one could look at parking it in a Fixed Deposit. However, in the case of both Recurring Deposits and Fixed Deposits please ensure that you can liquidate the amount at any time and be sure that you understand the charges for premature closure/ withdrawal. The more sophisticated investor can look to park this corpus in a liquid fund and also avail of tax-benefits. 

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