Importance of Emergency Funds

One of the tenets of good investing is to look at investing for the long term esp investments in equity related products need time to mature and deliver returns. Many assets be it Debt, Gold ,Equity , Real Estate investments all need a certain amount of time to bring their best.

So investors who have goals that are long term say 10, 15 and 20 years find it appropriate to use these assets to build their portfolios that will generate superior risk adjusted returns to them over that period of time. However it is important that these investments must stay invested through that period to generate that kind of returns.

What happens when you have an emergency for which you need money ?

Emergencies can come from anywhere and are by nature quite unpredictable. It could be a health emergency for an elder in the family, it could be a job loss or pay cut due to the pandemic or simply a difficult downturn at the business side so that the owner needs to forgo his paycheck for a couple of months. All these are real scenarios and have happened to us in some form or the other in the past.

Some people have the habit of breaking their long term investments to fund these emergencies. While they may do so to tide over the temporary cash crunch, they have inflicted an indelible impact on the portfolio returns in the long term. They have denied themselves the benefit of long term compounding that is very easy to imagine but difficult to achieve in real life. Between the 10th & 20th year, your investments will grow tremendously ( even without fresh inputs from you ) thanks to the compounding that takes place. People who tend to use their long term investing tend to miss the advantage of compounding that others enjoy.

However there are ways to overcome this issue :

  1. Planning for emergencies by buying adequate health insurance for health emergencies can help you from being out of pocket.

  2. Keeping monies invested in Short term Bank Deposits / Liquid Funds.. these returns may be low, but they are necessarily there for short term access when needed.

I would dare say, never start your investment portfolio construct unless you have provided an option for your short term emergency needs . That way you also feel less anxious and can stay invested on your longer investments far longer.

An emergency fund should be an essential first investment in your portfolio construct if you want to think of long term investing and creating wealth for yourself.

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