Financial experts believe that starting an emergency fund is one of the fundamental building blocks for building a strong personal finance foundation for yourself.
When you are not prepared for a financial emergency, the fallout is not just stressful but can have serious implications on your personal finance. That’s why you need to have an emergency fund to protect your financial well-being. With an emergency fund, you’re always prepared to deal with what life throws at you—good or bad.
This post is a comprehensive guide to emergency savings that covers why, how, how much, and where to put it.
What is an emergency fund?
An emergency fund is cash saved for unplanned expenses. It provides a financial safety net for unexpected expenses and future unfortunate events.
Why save for emergencies?
You may come across a number of situations in life that you have no control over. If any of those situations demand the urgent need for cash, an emergency fund can help.
Pulling money from mutual funds or selling your investments to cover emergencies is not a good option for a number of reasons. Firstly, your market timing could be bad, making you incur losses. Secondly, you may have to pay penalties for withdrawing early, and lastly, there could be a delay in the liquidity, which is the last thing you want when you are in an emergency.
A separate emergency fund to handle only emergencies is the right way to go about it. It gives you peace of mind, knowing that you have a little financial cushioning to ride out any unfortunate financial event.
For what type of situations do you need emergency funds?
Here are a few examples where emergency savings can help:
- pay cut due to pandemic
- lost job or layoff
- an auto accident or a major car repair
- began a new job that requires you to relocate
- major home expense such as a leaky pipeline, property damage due to natural disaster, etc.
- unexpected bills or unpaid bills
- unexpected medical expenses not covered or not fully covered by the health insurance plan
- death in the family that requires you to pay for the funeral and other costs associated with it
Many Indians aren’t prepared for an emergency.
The COVID-19 pandemic has wreaked havoc on people’s lives and their finances. The effects of it have been profound. Businesses have shut shops (temporarily or permanently), and many people have lost their jobs while others have to be satisfied with pay cuts. This has drained many people’s emergency savings.
Not having the money to pay their monthly expenses and their emergency expenses has created a pile of unpaid bills, leading to crushing debt.
Therefore, we all have to learn the lessons the pandemic has taught us and start saving for emergencies. The best time to start an emergency fund is now – when you are in a good financial position so that you are prepared when the unexpected happens.
How much to save for an emergency fund?
The amount you put aside for emergencies depends on your personal financial situation, income, expenses, and family size. Saving three to six months’ worth of living expenses is considered an ideal emergency fund size.
How to start an emergency fund?
Follow these tips to take steps towards starting an emergency fund:
- Write down your monthly income and expenses to find out how much you need every month for your expenses and how much money is left with you after paying them off.
- Decide how much you need to save to cover 3 to 6 months’ worth of realistic living expenses.
- Set a goal and develop a plan to achieve it. Your plan should be able to help you save up enough money every month to achieve your goal of creating an emergency fund in the shortest time possible.
- Keep your emergency fund where it is easily accessible. You need to put your emergency fund is in a liquid account where you have easy access to cash as and when you need it. A liquid account can be-
- Regular savings account at a bank
- Online registered digital chit fund platform
- Fixed Deposits
- Recurring deposits
The fund in these savings tools provides some return on your investment with the freedom of withdrawing the funds at any time.
If you consider other options like investing your saved amount in mutual funds, figure out how accessible the money will be in an emergency.
- Stick to your plan. This can be hard at times. But, if your goal is achievable and realistic, it won’t be difficult for you to stick to the plan. Some of the things you can do to stay true to your plan are:
- Save automatically by setting up an automatic transfer of money from your regular account to your savings account.
- A savings dedicated to emergencies can make a stressful situation easier to handle. So, don’t touch the funds unless it’s an emergency.
What are the other ways of getting an emergency fund?
If you haven’t been able to save up an emergency fund, there are other options for getting help to cover your financial emergency; however, you need to pay interest for using the credit for emergency use. Some of the tools are:
- Personal loan: It is usually an unsecured loan, easily available but charges a high-interest rate.
- Line of credit: it’s a revolving line of credit. The interest is usually high but is charged on the amount you withdraw from the approved credit limit.
- Friends and family: it is the most convenient option because you have no or low interest on the borrowed amount, but it can put you in an embarrassing situation.
- Community chit fund: The chit groups are usually created by your trusted network. You can get immediate access to cash at a very low-interest rate.
- Credit card: It’s a revolving line of credit with an exorbitantly high-interest rate. Using this tool is not usually recommended.
Starting an emergency fund is a vital building block for long term financial stability. Anyone can do it; this guide can help you set the right goals and develop a plan around them.