Why is an emergency fund Important? Let's build yours!
The global pandemic that started in 2020 continued to affect millions till 2021. The whole world was under lockdown. Several lost jobs, dealt with salary deductions, and faced the worst financial crisis. What never stopped was living expenses. As we know that life is unpredictable, and savings for emergencies will help you to cope with these situations.
The need for emergency funds is not just limited to covering unexpected scenarios but goes beyond that. Let's understand why it is so important and what are the best investment options for emergency funds.
What is an emergency fund?
An emergency fund is an amount that should be kept aside to meet your mandatory expenses without getting involved in mortgaging the assets, last-minute loans, or depending solely on credit cards.
To have an emergency fund ready, it is important to understand your necessary expenses. These include basic day-to-day requirements, food, rent, medicine, bills, and anything which is an indispensable part of your life.
Properties of is an emergency fund
Emergency funds are quite different from other investments as those are likely to support you during financial emergencies. So, you should consider a few things before selecting your emergency funds:
- A fund should be secured enough
- Should be accessible easily
- Emergency funds need enough liquidity
- No Lock-In
- It's ok not gaining from emergency funds but you should be aware that capital should be protected
Importance of an emergency fund
Staying prepared for sudden emergencies by securing future finances through emergency fund planning is important. Here are the important factors to make you understand why should you have an emergency fund!
Best for unexpected expenses
Emergency funds are a crucial corpus for unexpected expenses. It is the money you can rely upon during crisis hours, for unplanned and unexpected times. You need to plan it to overcome unforeseen financial expenses that may come at any time.
Comes in handy during a medical emergency
Medical emergencies are such unpredictable situations where you don't have an option but to spend money for treatment. People who have seen medical emergencies are of two types: the first category of people who panic about collecting such a big amount suddenly. The second category of people is those who have a sigh of relief because they have accumulated enough funds for situations like these.
Medical treatment comes with big expenses. Nothing can be more regretful than seeing your loved ones in pain due to a lack of funds. In such a situation, emergency funds work as a miracle.
Helps during times of unemployment or layoff
Preplanning is the key to survival in times of unemployment and layoff. It allows you to have enough funds to survive for a few months without earning. During this time, you can prepare for your next job without worrying about your expenses. It is best to have funds that could cover your few month's expenses.
Emergency funds are a significant way to ensure your financial security, apart from saving money for retirement. It also gives you the freedom to switch a job if you feel stuck in a workplace that is not good. You could anytime decide to quit your unsatisfactory job without worrying about debt and expenses.
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Backup for your investments
If you invest or are a long-term investor in equity, you are familiar with the market’s ups and downs. Events like global uncertainty, inflation, political crisis, etc. bring the market down significantly. This can be an opportunity to refuel your investment with your emergency funds. You can use a part of your fund to invest in equity. This small step can make your investment grow significantly in the longer horizon.
Reduces the need to rely on high-interest loans during emergencies.
Emergencies are one such situation where you can't have enough options to get money from interest-free sources. This invites high-interest loans which will affect major years of your life. Having funds will allow you to get through the situation easily without having to pay high interest on emergency loans.
Helps during major car fixes (in case of a major car accident or major car fixes)
Emergency funds can be a quick fix to vehicle damage or a car accident that you can pay then and there rather than using insurance. It will be used for the unanticipated cost of having a vehicle or annual maintenance. Using the emergency funds to pay these will allow you to maintain your insurance at the same monthly fee which is not very easy to maintain.
Ideal Instrument for avoiding the debt trap
An emergency fund will save you from stressful days and help you escape risky debt cycles much more quickly.
How to build an emergency fund?
Emergency funds provide a strong cushion to your financial goals. Here are a few promising ways to get started with building your emergency funds.
- Decide on the estimate of the amount you want to save
- Follow a monthly saving goal which will include a certain amount specified by you.
- Save your tax refund
- Analyze your savings after every 4 months and compensate it if the amount saved is less.
- Have a different account for an emergency fund and everything else (like car expenses, vacations, etc)
- After reaching a threshold of the amount decided, you can have another account for savings for emergencies.
Best investment options for emergency funds
Preparing a plan and working on it is the best way to reach your financial goals. There are Emergency Funds Investment Options. Select the one that resonates well with your finances.
- The best investment option for an emergency fund is having an account that you cannot access through your debit card. Debit cards are primarily responsible for pulling money out of your account. It can be an online saving account.
- After saving money in your liquid account, put some money in short-term bonds and savings accounts that pay good interest. From here, you can easily withdraw income during emergency times.
- Evaluate your existing assets. You might be having some assets that you can put in your emergency fund. This can be extra cash or some fixed deposits that are not goal oriented. You can channel them towards emergency funds.
- Liquid funds are great for achieving short-term financial goals with hardly any risk factor involved. They also give a better interest in comparison to the average savings account. They provide liquidity and higher return which is ideal to put your money to see as a viable option or take it out during an emergency.
- A Recurring Deposit is also a good tool for emergency funds. It provides a disciple’s way to invest your emergency funds, providing a clear picture of the time that you will take to build your emergency funds. They also provide liquidity and capital security. Short Term Gilt Fund is another good option to build emergency funds due to the low-risk factor and secure government bonds.
- Use investment options from where the process of money withdrawal is simple. The finance sector has many safe investment avenues. You should always give priority to emergency funds over returns by putting them in a well-performing bank and liquid. You can also put these into ultra-short funds that have a high-quality portfolio.
- People prioritize saving in Long-term or tax-saving fixed deposits, low-risk fixed deposits, and National Saving Certificates. However, these have a fixed tenure and have certain penalties for premature withdrawal in the case of an emergency. Therefore, investing in these funds might not serve the purpose.
- Finally, if you are running SIPs under equity mutual funds for long-term investment, don't stop or pause them. Continue your SIPs or, modify those according to your goals. You can any SIP Calculator in order to calculate or measure wealth.
How much emergency fund is required?
An emergency fund can be in any form. It can be as small as treating car damage or as big as coping with a job loss for months. The exact amount for you relies on your financial conditions.
The first step is to evaluate your monthly expenses that cannot be cut off. These include insurance payments, household expenses, and children's education. Calculate it for a few months to get an estimate. This can help you differentiate between your essential and non-essential spending. The number of months can be determined by understanding how secure your job is.
No one knows the tenure of an emergency or the bandwidth it comes with. The savings for emergencies should be such that you could pay your credit card dues, EMI's, and household expenses for at least 6 months. It should be enough for you to pay your liabilities for a few months without having a job in hand.
For example, let us suppose that your mandatory expenses are covered under 40,000 per month. In this case, you can take an estimate of 40,000×6 which is 2,40,000. Your emergency fund can be between 2.5 lac to 3 lac. This also depends on the number of earning members in the family.
In the case of a single earning member, you need to save more to cover the expenses of every dependent member of the family. If the family has two earning members, things will get much easier. Both the members can save up to fund emergencies.
Conclusion
An emergency fund should be a major part of your financial life. Every person should have savings for emergencies or unexpected times. Saving bit by bit will help you decide whether you will be going into debt or sailing through a financial storm. However, saving too much by cutting your important expenses is not a good idea. Make sure to be smart with the savings as these have a useful purpose.