If not anything else, the pandemic has driven home the importance of why you need to plan your finances well. The job loss, furloughs and pay cuts have thrown most of our finances into jeopardy. There’s not a better time than now to get started with your financial planning, especially the emergency fund part of it.
When you have a list of goals that you want to achieve in a certain time-frame like say, buying a house or going on your first international trip, it’s easier to plan investments suited for each, depending on the amount needed, the time-frame and other factors. There is, however, a much simpler way to go about it: the four-bucket approach.
Read on to understand this better.
Bucket 1: Emergency Funds
In view of the current situation, this should be your number one priority. With job losses and pay cuts becoming par for the course amid the pandemic, many of us may not have enough money to fulfill our financial commitments. This is where an emergency fund will come to your rescue.
Three to six months of your family income will be a good place to start when you’re planning for your emergency corpus. This number could keep changing based on your changing priorities, so make sure you have enough cushion to adjust those changes.
Bucket 2: Medium-Term Requirements
This bucket will take into account your medium-term goals, say, up to five years. These are goals that you can forecast with some certainty like paying deposit on a house you want to buy or changing your car. These goals are separate from your long-term goals not just because of the time frame, but also because they are more precisely predictable in time and amount.
Bucket 3: Long-Term Requirements
Your third bucket will include goals that are ten to fifteen years away. Goals that would go into this bucket could include your retirement, child’s education or marriage etc. One thing to note here is that for this bucket, predicting the right time-frame and amount you’re going to need is going to be a challenge.
For instance, when you’re planning for your child’s education when he’s only five years old, it’s hard to forecast how much money you’re going to need because that will depend on the course, college fees etc.
Bucket 4: Tax-Saving Investments
This one consists of your tax-saving investments. Although this category can be subsumed in one of the first two, it should be thought of as a separate category since it helps you save taxes which in itself is equivalent to earning. Depending on how you plan your tax-saving investments, there will be a lock-in period of at least three years. So you will have to stay invested for this duration even if you do not want.
Once you get a clear picture of which bucket to pour your savings into, you can place your investments in those categories accordingly.
For the emergency corpus bucket, you could consider bank deposits although many people also prefer Mutual Funds. For the short-term, you can consider hybrid or debt funds. And obviously, given the long time horizon of the third bucket, equity funds are ideal for this category.
Equity funds maybe volatile in the short-term, but they’re the only investment to offer inflation-beating, substantial returns in the long run.
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