How to Build an Emergency Fund to Avoid Financial Stress
Financial emergencies come unannounced. Job loss, medical emergencies and other financial requirements could contribute to financial stress if you don’t have an alternative plan to tackle such situations. This is where having an emergency fund could come in handy. Setting up a steadfast savings plan with an emergency fund is an essential way to protect yourself from financial predicaments.
This blog would help you learn how to build an emergency fund from scratch.
What is an Emergency Fund?
Emergency funds can be defined as funds set aside to meet urgent financial requirements. It can be broadly categorised under your savings plan, however, this particular fund is meant only as a financial back up in unprecedented situations.
Emergency funds come in handy when you have a sudden drop in your finances and you are in need of money urgently. Instead of burdening yourself with debt, you can utilise emergency funds to sail through any financial crisis. You always need a proper savings to rely on during the tough times and emergency funds can be of great help
Emergency funds come in handy when you have a sudden drop in your finances and you are in need of money urgently. Instead of burdening yourself with debt, you can utilise emergency funds to sail through any financial crisis. You always need a proper savings to rely on during the tough times and emergency funds can be of great help.
Why Do You Need an Emergency Fund?
Without proper savings, an unprecedented financial emergency can put you in distress. During these times, if you get involved in a debt, it can have a long-lasting impact on your future finances. This is why you need an emergency fund that will save you from getting into such a mess.
As per experts, if you already have been through a financial shudder, it can be difficult for you to save for future emergencies as well. This can put you in further debt and may make you pull out funds from other significant savings funds such as retirement funds.
One financial emergency can trigger a series of financial traumas. Hence, an emergency fund is an absolute necessity.
How to Invest in an Emergency Fund?
Planning for savings can be a little confusing for some. The general consensus is you need to have at least 3x to 6x of your monthly expenses/income as an emergency fund. For instance, during COVID, personal finance experts were of the opinion that everyone should have at least 10x of their monthly income parked as an emergency fund.
Here are some steps given below that you can consider while investing in an emergency fund:
1. Make a Budget
The first step is creating a budget. You need to decide a comfortable amount you can save towards an emergency fund. Calculate your monthly expenses and other financial obligations to decide this amount.
2. Save and Create a System for Consistent Contributions
Turn savings into a habit through discipline. This habit will be helpful in many scenarios; not only during an emergency. Set a goal and keep saving towards achieving the same.
3. Increase Your Savings Gradually
Ideally, with increased income, your savings should increase as well. Hence, you can consider making adjustments in your emergency fund once in a few months to increase the savings amount.
4. Monitor Your Fund and Keep Saving
Once you are on track, you just need to monitor your fund once in a while and continue with the process.
Point to note: There is no upper limit of emergency funds. Park as much funds as you can in line with your requirements to stay financially prepared.
How Much Do You Need in Your Emergency Fund?
This amount varies from one individual to another. But ideally, you should have 3 to 6 months of living expenses in your emergency fund. So, for example, if your monthly income is ₹40,000 and ₹20,000 of that goes towards your living expenses, your emergency fund should have anywhere between ₹60,000 to ₹1,20,000 or more.
How to Calculate Emergency Fund?
Wondering how to calculate your emergency fund? Check your monthly expenses (essential expenses) and income to plan accordingly.
But if you find it difficult to decide on an amount considering other bills and risks, you can use emergency fund calculator tools that are available online.
Using this calculator is an easy task. You just have to provide some information such as monthly living expenses, including EMI, insurance premiums and other obligations. The emergency fund calculator would give you an estimated number regarding how much you need to have in your emergency fund based on the details shared.
Where Should You Keep Your Emergency Fund?
Emergency funds should be highly liquid so that you can access it anytime as required; Recurring deposits and savings accounts could be one option. However, you should not have it entirely in cash.
You should consider investing some of it in mutual funds, recurring deposit accounts or liquid funds. This will help your fund grow as well as save it from getting spent during non-emergencies.
When Should You Use it?
Emergency situations may look different for everyone. Firstly, you need to decide the situations which are defined as an emergency for you. Not every unexpected expense can be an absolute emergency.
Setting these guidelines will prevent you from spending this fund on minor inconveniences and save it for actual emergencies. These can be accidents, medical expenses that your insurance does not cover, etc. Choose your emergency situations wisely and try to stick to the guidelines.
Final Word
Emergency funds should be highly liquid such that it is easily accessible in times of need.
Saving money is not that difficult if we have the will to do so. It is a good practice which we should imbibe in ourselves because a good amount of savings can help us and our family survive difficult and unexpected situations.
FAQs
Ans: You need to put at least 3x to 6x of your monthly expenses or income into an emergency fund. This would help you sail through during crunch situations.
Ans: Having an emergency fund is a type of saving your money but for a specific purpose. An emergency fund is built to save you from financial stress during unprecedented situations like job loss, medical emergencies, etc.
Ans: Since it’s a separate fund, you can open a different account solely meant for emergency funds. That way it would be easier to track the corpus you have built over time. Also, try not to withdraw an amount from the emergency fund to spend on things that don’t matter
Before you go…
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Disclaimer: This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
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