Life can surprise you, and while some surprises are fun, surprises that contain money can hit your wallet hard.
For such things, emergency funds are very important.
What is an Emergency Fund?
An emergency fund is a saved pool of money that is highly liquid, meaning it can be withdrawn almost immediately to deal with unexpected expenses.
While the exact amount in an emergency fund varies, the general rule of thumb is to save at least 3 to 6 months’ worth of your income, depending on your individual needs, lifestyle, and frugality.
Building an emergency fund allows you to remain calm and relaxed during rainy days. Having such a cushion, especially when you have dependents, is particularly comforting in case of medical, property, or any other surprise expense.
An emergency fund isn’t just a savings account – it is for financial stability, and the key is to ensure this fund remains separate from your regular savings or investments
Why Do You Need an Emergency Fund?
Here are a few reasons why you need an emergency fund as a part of your financial management:
Financial Security in Tough Times
An emergency fund will ensure that you are able to handle unexpected expenses. Be it a medical emergency, sudden job loss, or an urgent home repair, having a financial backup ensures you don’t need to borrow money or take money out of your investments.
For example, a lot of Indians experienced reduced income or lost their jobs during COVID-19. Those without emergency savings had to rely on loans or credit cards, which charge interest rates as high as 36% annually. With an emergency fund, you can avoid these financial burdens.
Reduces Financial Stress
Money problems can make anyone restless. But knowing you have some savings set aside for times like this can give you peace of mind. When you’re prepared, you can focus on your goals rather than stressing.
Prevents Debt Accumulation
If you don’t have an emergency fund, you will probably have to cover unexpected expenses by taking personal loans or using credit cards. However, this can lead to high-interest debt. A solid emergency fund will ensure you avoid such costly alternatives.
How to Build an Emergency Fund?
Now that you know why you should have an emergency fund, here are a few financial planning tips on how to build one:
1. Set a Target Amount
First, decide how much money you want to keep in your emergency fund. Financial experts suggest saving 3 to 6 months of your regular expenditure. This might include rent, groceries, utilities, and other essential costs.
For example, if your monthly expenses are ₹30,000, you should aim to save at least ₹90,000 to ₹1,80,000. However, starting small, like ₹10,000 or ₹20,000 is perfectly fine.
2. Create a Budget
Take a close look at how much you earn and spend. Understand areas where you can cut back. Try to cut back on any expenses that can be avoided and put that money toward your emergency fund. You can use any app or platform to help you track spending and save more efficiently.
3. Automate Your Savings
You should create an automatic transfer to a different savings account every month. Treat it like a fixed expense, just like paying your rent. This will ensure consistency and help you build your fund without even thinking about it.
For example, banks offer recurring deposit schemes where you can save small amounts monthly, starting as low as ₹500.
4. Choose the Right Savings Account
Where you keep your emergency fund matters. You should opt for a high-yield savings account or fixed deposit that offers easy liquidity and decent returns. For example, many Indian banks offer interest rates of 6-7% on savings accounts, which is better than letting the money sit idle.
You should try not to put your emergency fund in stocks or mutual funds, as they can be volatile. Remember, accessibility and safety are key.
5. Start Small and Stay Consistent
Building an emergency fund doesn’t happen overnight. Start with small, achievable goals like saving ₹500 or ₹1,000 a month and slowly increase the amount. Consistency is more important compared to how much you save at once.
For example, if you save ₹1,000 monthly, you’ll have ₹12,000 in just a year. Increase this amount whenever you get a bonus or raise.
Why It’s a Smart Move to Have an Emergency Fund
Having an emergency fund ensures your long-term investments remain untouched during a crisis. For instance, withdrawing from equity mutual funds during a market downturn can lead to significant losses.
By having a dedicated emergency fund, you can let your investments grow while managing short-term surprises effectively. It’s like playing defense and offense at the same time—your financial strategy stays balanced.
You should use an emergency fund only for emergencies like if you lose a job, need to repair your car or pay any medical bills. Make sure that you don’t use it for expenses like vacations or shopping. If you do use it, prioritize rebuilding it as soon as possible. Life is unpredictable, and having your safety net intact is important.
Conclusion
Starting an emergency fund might look scary, but it’s one of the smartest financial moves you can make. You should start small, save consistently, and choose the right savings tools. So, what’s stopping you? Start building your emergency fund right away!
