I always think what is the first step to create a financial plan?Also have been asked my opinion on this question by many times by friends. Before we answer the question, let us take a step back. For any plan to work, the plan should have a “cushion” to take care of emergencies. The “helmet” or the “seat belt” for driving as we can call the cushion. It is not very wise to plan a ride/drive if you do not have a helmet or your car doesn’t have a seat belt. And this cushioning is the first step to create a financial plan.
We will call this cushion as “Emergency fund”, which will prevent us from crash-landing the plan. The biggest reason, our plans dont work is because we have these “sudden needs” which are unanticipated. Car repair, buying a spectacle, supporting someone in the family, AC repair and what not – none of these are cheap. And these expenses can derail our financial plan. So best way for us to ensure our plan works is to create that “Emergency fund” which will ensure we dont derail.
So what factors do we consider in creating the emergency fund? This is a pretty subjective topic again, but there are some rules of thumbs which we can follow.
What is the amount we need to have as emergency fund?
Over a period of 2-3 years try to build the emergency fund to be equal to 6 months of your take home income. But we can start small and balloon it. ( 3 months of monthly expenses -> 6 months of monthly expenses -> 3 months of take home salary -> 6 months of take home salary).
Make the emergency fund grow over a period of time
It is great to grow the fund over a period of time and then once it reaches the threshold, stop the contribution.
Recently I started using Credit card to fund my emergencies
This I suggest only for people who are very comfortable using a Credit card and have that financial discipline to follow it. Essentially the Credit card gives us a one month cushion to repay, that is about it.
So the best first step to create your financial plan is to create an emergency fund. The emergency fund to ensure that the financial plan you create, has a cushion to prevent it from failing.
Two key aspects of the emergency fund is:
- Your family has easy access to this fund
- Easy liquidity – there is no delay in accessing the fund.
