While I encourage everyone to invest as much as possible, I’d also like to advice you to not be fully invested. I know this sounds a bit contradictory, but it actually makes sense if you analyze it. Some of us are excellent savers and investors to that point that any amount that we can save, we immediately think of investing. This is as much of a problem as people having trouble controlling their spending. If you optimize your investments to the point that you no longer have any buffer or flexibility left for unexpected expenses, you are in trouble. I have seen this happen to a couple of friends in the recent past and thought I’d pass on the advice so you can avoid similar mistakes.

Let me start with the back story first. A few days ago, a friend of mine was asking friends for a loan to pay for his kid’s school fees. He promised to pay back the amount in a month’s time. I trust this person and I know he will repay back in time. But how did he get into this situation in the first place? Not having money for paying kid’s fees seems like something one would normally not face. We Indians are especially clear on this. Education gets the highest priority in our list of expenses. The amount is not big either. It was Rs. 50K which is something like a month’s worth of expenses. Even if he did not have money in the savings account, he must surely have something in the emergency fund?

Lesson #1: Always maintain an emergency fund which is at least 3 months worth of expenses.

Ideally you should have an emergency fund of 6 months worth of expenses. This fund is in addition to the basic monthly expenses. Suppose your monthly expenses are Rs. 50K, then your savings account should at least have Rs. 50K in it at the start of the month. Then you should have an emergency fund of Rs. 1.5 lakhs to Rs. 3 lakhs which is 3-6 times your monthly expenses. Now, where should one keep this money? You should not invest it anywhere. Keep is where you can access it within minutes. This could be in the same savings account, which is what I do, or another bank account. But don’t touch the money except for emergencies.

If you like a small return on investment, then one option could be a sweeping FD, but make sure that your investment can be redeemed immediately when required. Another option would be to invest in a liquid mutual fund which has instant redemption facility. However, remember that usually there is a limit to the amount you can redeem using this facility, which is usually Rs. 50K. But you can get the money within minutes of putting in the redemption request. Of course you can redeem your full amount within one working day. If you think Rs. 50K might be too less for instant money, then spread your emergency fund into 3 to 6 liquid funds. Although, I do not suggest this approach because it becomes cumbersome real fast.

Because of all the above reasons, I keep my money in savings account. There is no risk of delay in redemption. No need to worry about business days or holidays and no need to clutter the portfolio. Of course it may not work for everyone, so pick your pill. Some feel anxiety when leaving the amount uninvested and not growing in a bank account. But that is not the purpose of emergency fund. It is not an investment in the sense that it should grow. It is an insurance for unforeseen emergencies.

Lesson #2: Emergency fund is not an investment, it is an insurance.

It is not sufficient to keep an emergency fund, you have to take care of its health too. Why is that? Well, to continue the story of my friend, I asked him why he could not use the money from the emergency fund for the kid’s fees. I was sure that the fees is much less than the emergency fund. His response was that the emergency fund was exhausted too. That is where we come to the point about emergency fund’s health. You see, whenever you dip into the fund, you need to replenish it as soon as possible. As soon as possible does not mean in a few days or months. It means right away. Let me explain with an example.

Suppose you have an emergency fund of Rs. 3 lakhs and have used Rs. 2 lakhs for some emergency. As and when you are taking out the money, log into your investments account and redeem as much money as you have used up. In this example that is Rs. 2 lakhs. Now which fund to redeem from? It should be debt mutual funds of course. I am sure you have at least some money in a debt mutual fund unless you are very young and have all your investments in equity. You should always have an asset allocation plan and invest accordingly. So you log in to your account, and redeem Rs. 2 lakhs from your debt mutual fund.

Generally emergency fund is such a small amount compared to your corpus that it shouldn’t really affect your asset allocation by doing this redemption. However, if you have been redeeming continuously from debt funds for emergencies then perhaps you might have to rebalance your asset allocation. If you put in your redemption request before 3 pm, you will get your money the next business day and then you replenish your emergency fund. If you redeem after the cut-off time, you will have to wait for 2 business days. If you have been unlucky and sold on a long weekend then you might have to wait up to 5 days. That is what I mean by as soon as possible. These days you can do everything on your mobile. So you can transact from anywhere at anytime.

Lesson #3: Always replenish emergency fund as soon as possible.

I don’t know the particular situation of my friend and why he could not replenish the emergency fund before the next emergency hit him, but let it serve as a lesson for everyone of us. Of course it is entirely possible that multiple emergencies happened in such quick successions that you could not recover the health of emergency fund in time. That is when your friends come to rescue. Unfortunately, I was in a situation where I am facing my own emergency expenses with our farm (will come in a post in future) and hence I could not arrange money for my friend. But if his emergency was a major one, I would have arranged no matter what. That brings to memory another money request from another friend.

During the COIVD time a friend of mine had the unfortunate situation that one of their parent passed away and he needed money. Perhaps he exhausted his emergency fund and could not replenish it given the situation (bereavement) he was in. I never asked. That is a real emergency where you never ask questions and just send the money which is what I did. So these are one of those situations where emergency fund cannot do everything even though it is meant for emergency.

Now coming to the title of the post – don’t be fully invested. At another time a friend asked for a loan to do a down payment for some loan and promised to return within one or two months. I started to wonder why one would ask money for a down payment. If you cannot afford to buy the thing with your own down payment money and loan, then you probably shouldn’t buy it. Anyway, it is not my business to involve in their affairs so I asked why he did not liquidate some of his investments and do the down payment. His response was that he did not want to sell his investments because he did not want to lose the returns on investment. Instead he prefers to take a loan from a friend and repay the loan over the next 2 months or so. That does not make any sense to me.

Lesson #4: Don’t be fully invested.

By asking for a loan you are basically asking your friend to redeem their investments and let them lose their returns because you don’t want to lose your returns. Does not make sense. Anyway, I am not concerned about losing returns on my investment for a couple of months because it would amount to such a small number that it really does not even make sense to ask a friend. Suppose you are asking a friend for Rs. 2 lakhs loan (without paying interest of course) with the intention of paying it back in 2 months. Lets do some calculations on how much money you could be saving.

Suppose are a super investor and invested all your money in some investment vehicle that is generating 24% per year which is about 2% per month. Then your Rs 2 lakhs investment would have generated you Rs. 4000 per month. So you could have saved Rs. 8000 in 2 months. I don’t think that is a lot of money and you should burden your friend. But this is very hypothetical example. In reality no one every invests all their investments in a risky 24% RoI investment. You probably have heard of asset allocation and have at least some of your investment in safer fixed income investments which generate about 6% per annum. That translates to roughly 0.5% per month which means you would be saving Rs. 1000 per month or Rs. 2000 over 2 months. Do you really want to take a loan from a friend to save that?

The only reasonable explanation I could imagine for the loan request is that perhaps my friend is fully invested in an exceptionally high RoI investment and taking out from there would mean losing a lot of money. On the flip side, by asking your friend, you are assuming your friend does not have as good of an investment as you do and you are fine with having that friend lose their return on investment for the 2 months. If it is a real emergency then you can ask your friend for the money today and tell them that you will sell your investments and return the money in 1 or 2 days and not in 1 or 2 months. One with a good financial plan should never have to depend not just on friends, but anyone at all. I feel, one should always be independent and empowered especially when it comes to finances.

Lesson #5: Ask a friend for help, but only for real emergencies.

From all these and many more conversations with various people I had in the past, I am coming to the conclusion that some people are so fully invested that they fear taking money out. I have given examples of my friends and I know some of them read my blog too. So I am aware that they will be identifying themselves or might know who I am talking about. The reason I gave these examples is so that others can learn from my experience. I am sure all the friends mentioned above have strong reasons for asking loans. May be there is no other solution for them. This is very one sided (my) account of events and I have no idea what other problems they might have been facing when asking for the loans. As a disclosure, I told my friends that I am going to write a post about their situation in the hope that they and others in similar situations will plan their finances better.

If you don’t already have an emergency fund, stop all your investments right now and build the emergency fund first. Don’t worry about investments because without emergency fund, you don’t even have the basics right. Put all your savings into the emergency fund till it reaches 3 months worth of expenses. From there continue to build your emergency fund to 6 months worth of expenses while building your fixed income part of corpus, as explained next.

Make sure you have a low return but safe investment called as fixed income. The amount depends on your situation so talk to a financial advisor. My general advice is to have 30% of your corpus in a fixed income asset class. But it may not work for everyone. So if your total corpus (all your investments) is Rs. 100 lakhs, then you should have at least Rs. 30L in fixed income. A fixed income usually is a ultra short or short duration debt mutual fund for the tax benefits, but it could also be a fixed deposit, PF, NPS etc. If all your fixed income investments are in illiquid assets like NPS, PF etc, then consider creating an FD or ultra short term debt mutual fund with 1 year - 3 years worth of expenses. Build the fixed income part after building the emergency fund.

Any time you use any money from emergency fund, you immediately (the very same day if not the same minute) need to sell from the fixed income part of your corpus and replenish the emergency fund. Then, the next time you receive your salary, you need to replenish your fixed income to bring it to the same asset allocation as you prefer. So in the example above, if you used Rs. 2L from emergency, sell Rs. 2L worth of fixed income the same day. Then invest the Rs. 2L into fixed income as and when you receive your salary. Don’t be greedy and always think about investing and getting high return on investments. Sometimes safety is more important than returns.