However, life teaches us that an emergency can strike at any time. The pandemic is one such example. There could also be natural disasters such as earthquakes or floods, deteriorating health conditions, job losses during recession etc. In such cases, you may need additional funds to steer your way back to normalcy.
This is where strong financial planning comes in. By keeping emergency preparedness as one of the smart goals in your financial planning strategy, you can easily sail through these unexpected circumstances.
Let’s first understand what an emergency fund is. It’s a type of fund that helps you manage unexpected expenses and avoid last-minute loans, excessive credit card withdrawals, or selling or mortgaging your assets.
Hence, an emergency savings fund is an important part of your personal finance. Perhaps the best way to describe it is in the form of a fire extinguisher: you expect to never make use of it but you are always glad to have it in case of an emergency.
Why you need an emergency fund before retirement:
● To protect long-term investments – One thing to consider during investment planning is to not withdraw from your retirement corpus at the wrong time. This is because you’re likely to incur a loss if the market is down. This is a possibility during recessions. An emergency fund protects your portfolio by allowing you to withdraw from the fund instead.
● To help cover your medical costs – Healthcare may sometimes create great dents in your savings. Apart from life and health insurance, emergency savings are a great way to ensure your other savings don’t get eroded.
● To ease the loss of a job
– Investing the money earned from your job is an important part of personal finance goals in your 50s
. If you lose your job due to unexpected circumstances, then your contingency fund can come in handy. Again, once you retire, you can rely on a part-time job to supplement your income. In case of a loss of that, you can depend on your emergency fund.
● To protect yourself against inflation – Inflation is something you can’t control. Once you retire, inflation can dip into your savings easily and cause your regular expenses to rise. An emergency fund can help you bridge the gap between the actual cost of goods and services and what you expected to pay as per your financial planning.
3 types of emergency funds to build before retirement
Most people are unaware of how to deal with unexpected expenses when they arise due to lack of a proper emergency fund. Below are 3 essential types of emergency funds you should always have:
|Rainy Day Savings Fund||This fund is for managing expenses that arise out of budget, such as minor accidents, home repairs etc. Ideal for temporary, one-time expenses. |
|Emergency Savings Fund||This fund is for major incidents such as loss of permanent or partial job, major illness etc. Ideal for significant events, with at least 6-12 months’ coverage recommended. |
|Retirement Savings Fund||This fund is ideal to manage your retirement life so that you don’t have to depend on your emergency fund. Ideally this fund should take care of your living expenses once you retire from your job.|
How much should you save for an emergency fund?
How much you need for your emergency fund depends completely on the financial cushion that you require to make you stress- and worry-free. To start with, you can list the total monthly expenses you have:
● Property taxes
● Lifestyle and essential expenses
● Medical expenses
● Groceries and consumables
● Insurance premiums (health and life insurance etc.)
Once you have the monthly expenses listed out, you need to figure out how many months of expenses you require to be taken care of, to feel comfortable. Most financial planning experts suggest at least 6-12 months of expenses should get covered by the emergency fund.
Where (and where not) to keep your emergency fund
The primary goal of an emergency fund is to provide you with ready money when you need it. So ideally, you’d want it to be readily accessible. It should also be immune from market volatility or liquidity issues.
, you might go in for fixed deposits or savings accounts. However, these aren’t ideal ways to maintain emergency funds. . Fixed deposits have early withdrawal penalties and the returns on savings a/c are low..
A money market mutual fund may be the best solution in this case. Ultimately, it depends on your choice, comfort, and the rate of returns you can expect.
3 questions to help you take the right decision:
● How quickly will you need the money?
● How important is the interest rate in your decision-making?
● Do you need access to a bank branch or are you okay relying on online transactions?
Answering these questions will determine the form your fund takes. Whatever its exact configuration, it is important to build substantial emergency funds to tide you over a crisis, so that you can live worry-free and be prepared for anything life throws at you.