What is Core & Satellite strategy?

The last few tumultuous years have driven home the criticality of having an adequate emergency fund. After all, personal financial disasters such as a job loss, a business windup or a sudden medical emergency can have devastating effects on one’s financial goals. More uncommonly, there may be unexpected income tax demands, critical home repairs to make or even a recovery from a natural disaster to deal with. Any of these events can derail your finances.

For a new father, it becomes all the more important to be prepared for such emergencies since they now have one more dependent who would be impacted by any life event that leads to financial instability. Moreover, most new fathers are still in the early stages of their careers, and are often saddled with home and vehicle loans or still paying off education loans. Many of them may still be finding their niche in their careers and are still a few years away from their highest earning years. All this makes emergency fund planning even more important.

How much is enough?
The standard advice is to have 6-9 months expenses as an easily accessible emergency corpus. However, this is just a rule of thumb at best. The more unstable your present situation, the larger your emergency fund needs to be. For instance, a startup founder should ideally have 18-24 months’ fixed expenses as an emergency fund. On the other hand, a government employee with a more stable income could make do with an emergency fund that’s as small as three months’ expenses. Also, the more dependants and family members you have, the larger your emergency fund needs to be. Your scope for relying on close family members in case of dire emergencies is also a key determinant of the right amount for you. Eventually, you could decide on a number that is between 3-24 months fixed expenses.

How to get started
You might need to cut a few corners for a while time to free up surplus to divert towards your emergency fund. Think of it as short-term pain for an important long-term cause.
Whatever you do, do not leave the emergency funds lying in your savings account! You will invariably end up spending it. ‘Out of sight, out of mind’ would be an effective rule to follow here. Invest this money through SIP’s instead of accumulating the moneys in your bank account. Even Rs. 15,000 per month saved at a return of 6-7% per annum can help you accumulate a fair emergency fund within a couple of years.

Where should it go?
Equity funds can be volatile, and the last thing you would want from an emergency fund is for it to go down in value significantly when you need to access it. Since safety is of paramount importance when it comes to your emergency fund, you should invest at least 80% into liquid funds, floating rate funds or arbitrage finds. Up to 20% could be invested into slightly higher risk funds like dynamic asset allocation funds or debt-oriented hybrid funds, to provide a small kicker to the overall corpus.

Common mistakes
The first, and most obvious mistake, is to ignore the need for an emergency fund altogether! You may be surprised at how common this is. Optimism is great, but do not bury your head in the sand and assume that life will pass you by leaving you unscathed. After all, emergencies are called emergencies because they do not come announced. Getting started is key, even if it means doing so with a smaller amount.

The second mistake is to occasionally dip into your emergency corpus to fund lifestyle expenses, with the intention of topping it up later. This can lead to a situation where you do not have access to adequate capital when you need it the most. Not redeeming a neat pile of liquid savings for a vacation or a new car is difficult, but one must exercise willpower to maintain the corpus keeping their family’s future in mind!

The third mistake would be to mix your emergency fund with your other goal-based investments – for example, saying that “I’m saving this money for buying a home, but will draw upon it in case of an emergency.” Your emergency corpus must be maintained separately, with a clear strategic focus on capital preservation and high liquidity. Working with a qualified advisor to define, prioritize and plan your goals can be extremely helpful in this regard.

The author is Chief Business Officer, FinEdge. Views are personal