What is an emergency fund?
It serves as a backup in a financial crisis. This keeps a person self-sufficient during times of need and one doesn’t need to heavily rely on any kind of loan taken from either financial institutions or relatives.
How prepared should you be for an emergency?
Job loss: The primary earner in the family loses their job and monthly income into the household is interrupted. Other instances are that of a freelancer not having projects to work on for months or businesses not generating revenue. There are many professions where people work on contracts: Sometimes they may have too much work, at other times barely.
Medical crisis: A medical crisis in the family that may lead a person to spend a large amount of money out of their pocket in addition to the health insurance he may have opted for. A person may have to leave their job to get treated for an ailment, creating two problems: Illness and job loss.
Repairs: An emergency repair to your vehicle or house such as seepage in walls, fencing to avoid encroachment etc. cannot be avoided.
What is not an emergency?
Sometimes you may not have an emergency but may feel that you are in one because of ill planning. For instance, you may not have enough money to splurge on an ongoing sale or you overshoot your budget on a holiday. These instances may not lead to financial paralysis but definitely need to be planned properly so that a financial fiasco is avoided.
How large should an emergency fund be?
Buffer should be built for three months, six months or nine to 12 months based on your spending pattern, your age and number of people dependent on you, if your job is stable or you are working as a freelancer. To get an idea of the buffer, calculate yours or your family’s necessary expenses of the month from your salary. Multiply this with the number of months you would want to create a backup for and you will get a number.
How should the amount change after marriage, children, debt, or job uncertainty?
|
Description |
Buffer to be built for |
|
Young, single person who has taken a job recently |
If a single person is earning Rs 30,000 per month and his expenses are Rs 15,000 then he has to have a buffer of at least three months to face uncertainties. That means, he has to build an emergency fund with at least Rs 45,000 and then build it further. However, since the person is young and has no dependents, he can do some future planning and stretch and save more that will be helpful for him in the future. So, instead of stopping at Rs 45,000 he can continue saving for his emergency fund from the fourth month even if he chooses to reduce the saving from Rs 15,000 to maybe Rs 10,000. |
|
Marriage, dual income no kids |
Three to six months. In this case since there are no dependents and both members are earning, one can save a good corpus. |
|
Marriage with dependents |
In this case, you should build around 12 months of corpus simply because of the number of people depending. |
|
Unstable job or under debt |
This is also a risky situation and hence one should build a corpus of at least 12 months so that any untoward situation can be handled easily. |
Where to keep your emergency fund?
To be prepared, your funds should be safe. You should keep money in a savings account so that it is easily available in a crisis and lasts for three months at least. Also, a major part of the emergency fund should be risk free even if the fund doesn’t earn much interest returns. Once the first three months are sorted, you can save the other part of the emergency fund as fixed deposits that should take care of five to six months. Finally, when this is also significantly saved, opt for instruments like mutual funds where you will get returns based on market movement.
Build your emergency funds in separate accounts as you would not want to mindlessly spend the money when you are also doing your monthly expenses. That also ensures that one doesn’t suffer in case of a technical glitch and the bank is unable to process the money on time.
How to rebuild the emergency fund?
Any time you are forced to use a part of your emergency fund, then it is your responsibility to start rebuilding it.
You can resume with a small amount but a quick start is necessary because as time passes one may lose the seriousness that it deserves and in time may get into trouble in case of an emergency.
To rebuild your emergency fund, calculate the amount that has to be saved to rebuild and spread it across the several months it may take. While you are in the phase of rebuilding your emergency fund, it is recommended to go slow on your spendings outside that of essentials so that the fund can be built at the earliest possible time.
Finally, while calculating the emergency fund, do not underestimate inflation. Calculate clearly how much money you would need in the time of crisis after exactly taking into account all the necessary expenses to be done and make a plan to save this money. What is also tough is not to touch the emergency fund at times other than an emergency.
FAQs
Can I lend an emergency fund and earn interest?
It is not at all recommended to touch your emergency fund and earn income from it in the form of interest. It may happen that at times of emergency you may not have access to your fund leading to financial trouble. Also, never invest your emergency fund to earn returns.
Are health insurance and emergency funds the same?
No, health insurance and emergency funds are not the same but complement each other. But in a medical emergency you may need to only touch a part of your emergency fund.
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