Why You Should Build an Emergency Fund

It’s been said that “life is what happens to you when you are busy making other plans”. In other words, life is unpredictable. Emergencies can come out of the blue and impose huge financial burdens. The pandemic has shown us that even the best-laid plans can be derailed by a sudden job loss or health crisis.
Dec 2022
4 mins read
An emergency fund allows you to handle these troubles without undue stress or anxiety and without having to compromise too much on your lifestyle. It will also stop you from spending money on credit cards or borrowing funds in a pinch, which could otherwise land you in even deeper financial strife.

Things to remember before building an emergency fund:

  • Define what an ‘emergency’ means to you, so you won’t tap the fund unless it’s a real emergency

  • Park your fund in liquid instruments so you can access the money quickly in an emergency

  • Aim for a fund that enables you to maintain your lifestyle for at least 6-12 months in a crisis

  • Make it a habit – set money aside periodically rather than all at once. This will also ensure budgetary discipline and preclude overspending

  • Don’t confuse an emergency fund with your savings. Savings should be kept aside for investment and wealth creation
How to create an emergency fund

  • Budgeting for the month: Sit down with your family and work out a monthly budget. You should be able to reach a median figure that allows you to meet expenses and live comfortably. This figure will be the basis of your emergency fund calculation.

  • Sizing up your fund: The target size of your fund is (your average monthly expenses) multiplied by (your fund duration). Experts recommend keeping at least 6-12 months of average monthly spend as emergency funds. A qualified financial advisor can help you create a sizable emergency fund that is best suited to your income inflow and expense outflow.

  • Apportioning money: Once you have budgeted your monthly expenditure, you will have money left over. For example, if your take-home pay is Rs. 50,000, then around Rs. 30,000 would go towards expenses like bills, rent, EMI, debt payments, groceries, etc. Of the remaining Rs. 20,000, you could put half i.e., Rs. 10,000 into investment instruments such as mutual funds, exchange-traded funds, the stock market, etc. – avenues that will generate good returns over the long term. The remaining Rs. 10,000 can be split 60:40. i.e. you put Rs. 6,000 into your emergency fund and keep Rs. 4,000 as cash in hand.

  • Parking the fund: ‘Park’ your emergency funds in liquid financial instruments, so you’ll have easily available cash in an emergency. Instruments such as savings accounts, recurring deposits, fixed deposits and post office savings accounts will all let you withdraw money quickly with minimal paperwork.

  • Making the fund earn: Once your emergency fund is close to your target, you can make the money earn for you. Speak to a financial advisor about parking a smaller portion (e.g. 40%) of the fund in the liquid instruments, and a larger portion (60%) in something like a liquid mutual fund, which delivers higher returns.

  • Apportioning lump sums: If you get lump sum amounts such as a salary bonus or a cash gift, divide that too, such that a larger portion goes into your emergency fund and a smaller portion can be used to treat yourself and your family – as a reward for your fiscal discipline.
Once your fund is set up, just review it periodically in consultation with your financial advisor – and then sit back, relax and enjoy the peace of mind you’ve just bought for yourself!
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