What is emergency fund ratio?

The lower the time taken to convert an asset to cash, the more liquid the asset. Examples of such assets include bank fixed deposits, listed equities and open-ended mutual funds. Real estate and long-term debt and other types of equity investments fall under the 'illiquid' category.

Additionally, the lower the cost incurred to convert the instrument to cash, the more liquid the asset. Some assets have penalty or applicable exit load which adds to the cost for example mutual funds. The withdrawal restrictions imposed by banks or mutual funds can be catastrophic if you need the money for immediate use in an emergency.

The lower the price fluctuation in a quick sale of an asset the more liquid the asset. Liquid equity stocks can be sold without significantly lowering its price like the index stocks.

Emergency fund ratio or liquidity ratio is a personal finance ratio that measures the ability of a household to meet expenses out of the assets that can be easily converted into cash. It is computed by dividing the total liquid assets of the household by the total monthly expenses of the household.

In personal finance and financial planning, it is recommended to maintain an amount equal to six months’ expenses worth in liquid assets for emergencies. Experts say it makes sense to keep some portion of your emergency fund in hard cash at home. Savings bank accounts are easily accessible for urgent cash requirements too. The covid-19 crisis has been testament to this, many found themselves strapped for urgent cash or suffered setbacks such as job loss, pay cut, medical emergencies etc. In times of crises, emergency funds and liquid assets can really help.