“There is always something coming your way in a few months, so be prepared.”
This quote precisely dictates the importance of saving for an emergency. With the changing lifestyle and rising costs, emergency funds are the need of the hour. Say an urgent purchase comes up, or, worst-case scenario- you meet with an accident. Such unplanned expenses may not be a part of your budget and can drain your bank account. In such cases, an emergency fund is your savior.
During an emergency, you cannot arrange a large sum of money immediately, but if you already have it saved, you can handle the situation like a pro! An emergency fund supplies adequate financial assistance in uncertain circumstances and helps you protect your savings and income.
To understand how to save for this fund without interrupting your monthly budget, read this article.
What Is an Emergency Fund?
If we have to give an emergency fund definition, it would be – the money people have in reserve and can use in times of financial distress. An emergency fund provides a safety net against financial uncertainty for you and your family.
The COVID-19 pandemic was an eye-opener to teach the importance of having an emergency fund. A common reaction of people in such a time is to take debt, which might help in the immediate future but can create a long-term credit liability. To avoid falling into this debt trap, saving for an emergency fund is non-negotiable.
An emergency fund is usually in a cash form or highly liquid assets. Having an emergency fund reduces the need to withdraw from your savings account. This will help you manage your financial responsibilities smoothly while also giving you an opportunity to find a new way to earn money.
What are the Benefits of Having an Emergency Fund?
Having an emergency fund can save you from many financial perils in life, including unexpected medical bills. You can keep yourself at bay from taking high-interest loans or any other financial interest-laden aid. We have listed a few benefits below.
1. Helps in maintaining a budget and provides financial security
Emergencies don’t knock on your door, announced. It can dry out your funds and income when you least expect it. Your budget will falter, and you’ll have to cut down on other necessities. An emergency fund makes you immune to that situation.
With regular monthly savings, you can build an emergency corpus in your savings account or a fixed deposit, which you can withdraw at the time of need without hampering your daily life. Moreover, you will be financially secure since you have a buffer for each situation that may come your way.
2. Helps you handle financial challenges during a job loss
A job loss, especially when you have the responsibility of your family, can be a heartbreaking situation. During the pandemic, many jobs were lost, and businesses were shut down. Those who could sustain themselves did so on a meager income.
That’s why it is important that you build an emergency fund that can help you keep your finances afloat if you face a job-loss crisis. This will also give you some time to find another job or start a new venture.
Based on your family condition and your future responsibilities, save an emergency fund equating to at least 6 months of salary. You can also increase it to a year’s worth of salary. The choice is yours, but the crux of the point is to have an adequate emergency fund.
3. Helps in tackling medical emergencies
With the increase in sedentary lifestyles and diseases spreading like wildfire, you never know when you might need to visit the ER in a hospital. Medical bills, along with medical inflation, are soaring. Medical inflation is calculated as the increased hospitalization expenses, available doctors and nurses, advancement in medical tech, etc. It directly affects the bottom line of your medical bill.
If you don’t have medical insurance or if you have, but due to some condition, you cannot get the benefit of the same, the financial burden may fall on your shoulders. This can be a terrible situation unless you have enough money saved up in your emergency fund.
By having an emergency fund, you can be financially as well as emotionally strong for yourself and your family. You won’t have to take a loan or rely on other lending methods if you have some money saved for such situations.
How to Build an Emergency Fund?
You can use the mentioned step-by-step guide to build an emergency fund.
1. Set a savings goal
If you set your goals in advance, the task of saving will be less daunting. After your expenses and other necessities are met each month, you can set aside a fixed amount to build an emergency fund. The ideal way is to set up an automatic transfer that deducts your money and credits it to a recurring account every month. This will separate your emergency funds from your regular savings, and you will have financial security in the time of urgency.
2. Don’t splurge
Some purchases are necessities, while others are just done on a whim. If you cut down on those impulsive purchases, you’ll be left with a massive chunk of money to save each month. Thus, make it a habit to separate your needs from wants and be more disciplined with your finances. This will also keep your finances sorted so you don’t live paycheck-to-paycheck.
3. Save on taxes
You can save money on taxes and use that amount to save an emergency fund. This can be done via efficient tax planning as well as by getting a tax refund. Tax planning by investing in liquid tax-saving instruments can help you save money which you can transfer to your emergency fund. Also, you get a tax refund once a year. Make sure that you transfer this refund to your emergency fund account. Do not consider the refund as your income.
4. Invest your emergency fund
Putting your emergency funds in an account with a good interest rate will ensure they grow exponentially. Because this fund is required for emergencies, investing in fixed-income instruments such as bank FDs or recurring accounts is a good option. Another fixed-income product you can explore to earn up to 10% returns while beating inflation is Mudrex’s Vault. This way, you will grow your emergency fund passively.
Once you’ve saved enough for 6 months, consider saving for another 6 months instead. This way, you’ll have a solid fund that will navigate you through emergencies stress-free.
How to Calculate Your Emergency Fund?
The rule of thumb for emergency savings is to have it cover at least 6 months of your family’s expenses. For example, if your monthly salary is Rs. 25,000, you need to save Rs. 25,000 x 6 = Rs. 1,50,000.
You can also save an emergency fund based on your expenses. For this, you need to add the expenses of one month and then multiply that by 6. That is the total amount you have to save for emergencies. For example, if your monthly expenses come to Rs. 20,000, you need to save Rs. 1,20,000 for your emergency fund.
You can also save a lump sum amount. However, having a strategic approach is better. You can set up monthly deposits to save a certain amount for your emergency fund.
Please note the calculation can differ based on your income and mindset. Some people would like to save for more than 6 months. If you prefer that, simply multiply by the number of months you’d prefer to save for.
To achieve your goal of saving for emergencies, set guidelines for yourself. You should consult a financial advisor if necessary and set up a checklist to ensure you adhere to your saving goals. This way, you can ensure that your bank account is not drained, and you don’t have to stress over arranging money during emergencies.
1. Is savings the same as emergency funds?
An emergency fund is a type of savings, but not all savings are for emergencies. You can save for multiple purposes, like buying a house, retirement, etc. Savings is a generic term, while an emergency fund is a more specific term; here, you save for a rainy day to secure yourself and your family financially.
2. How much money should I put in my emergency fund?
You should at least put 6 months’ worth of expenses or salary in your emergency funds. If you lose a job, looking for a home, or going through an illness, 6 months’ worth of emergency funds will keep you financially secure. Also, in 6 months, you will also get time to figure out your next move.
3. What’s the 50-30-20 budget rule?
The 50-30-20 rule of budgeting helps you divide your income into various categories to ensure that you have money for your daily needs as well as what you are saving. According to this rule, you spend 50% of your income on your needs, 30% on wants, and the last 20% is saved. You can save 20% for various financial goals, including building an emergency fund.