How to build an Emergency Fund: A step-by-step guide of what it is and why it matters
For the past one year, many of us have gone through uncertainties like job loss, business loss, salary cuts and even some met with bankruptcy due to COVID-19 impact. This is the reason why it is always a great idea to save some part of your income for your unforeseen needs or a need which is known as emergency or contingency. Analysts always suggest people to keep some part of their money aside to pay for unforeseen circumstances or future expenses. It can be large or small like medical expenses, unemployment, accident, car, or house repairment, home appliances repair or replacement, shifting home, any bills which need to be settled in full and final. So, anything which is unexpected and without financial support cannot be resolved is known as emergency or contingency fund.
Why do we need an emergency or contingency fund?
In-order to give one a financial buffer during any emergency in life money plays a very vital part. So, we always need emergency fund to avoid any more debt or rely on credit cards or borrow money from someone. If you are already in debt, then it is must to keep your emergency fund portfolio more weighted. Suppose you lost a job or suddenly you need to shift your home, or any medical need comes, then you cannot always borrow money from your friends and family or take loan. It is better that you save some part of your money from the very beginning of your career. Emergency fund will no doubt help you like a savior when you go through any financial crisis in your life and prevent you from getting into any further debt. This is the reason we all need emergency fund to support our financial buffer situation.
How to build an emergency fund?
Always calculate the amount which you want to save:
Try to use calculator app from good financial websites and calculate your total income, expense, and then put aside some part as contingency fund. Remember 15:15:70 formula while saving for emergency. Which means 15% as cash, 15% as savings in bank and rest as liquid fund investment. Keep at least six months of your income aside which should be equal to your six months’ salary.
Set a monthly savings goal for emergency need:
Keep one bank account to save your money separately with discipline and patience. Once you decide the amount you want to save just transfer the amount into your savings account regularly. It is always healthier to set auto debt system linked with your savings account. This will retain you away from any sort of daunting.
Do not just splurge your income every month:
Draw a line between your emergencies and rest everything related to finance. Forget about the savings account which you are using for emergency need. Just save your money systematically every month without any break. Make strict rules that a part will go to your savings account at any cost with discipline.
Keep emergency fund liquid:
Put your contingency savings account or in such funds which can be withdrawn easily and convert into cash in an hour when you need it immediately. Liquid fund is must for contingency need without any delay.
Try to check the exit and overload costs, penalty costs as well before withdrawing the money with the help of calculator. If you want some extra return or interest, then save your money in short-term or medium-term bank fixed deposits which you can withdraw very easily.
Divide your emergency funds into two categories:
Always divide your emergency fund into two categories. One is long-term emergency funds and the second one is short-term emergency funds. Use 15:15:70 formula while saving for emergency. Which means for short-term put 15 percent as cash, another 15 percent in bank FDs and Saving accounts and try to put 70 per cent as short-term or long-term investment in deposits or liquid mutual funds.
If you think apart from short-term needs, you may require some long-term emergency funds like after any sabbatical or planning. Then you should invest in some safe mode of funds.
You can always redeem the liquid fund amount soon through mobile app, website or through internet banking when you need. Some may take 1-2 three days to redeem in cash but else it is a very good option to save money.
Formula to save: Suppose you saved Rs 1 Lakh as an emergency fund. Then try to keep 20% of your saving as cash at home, 20% in your savings bank account and rest 60% of your money try to invest in your savings bank account. Also, if you need 1lakh as contingency fund and your salary is suppose Rs 30,000 monthly then save at least 5,000 or 10,000 by cutting down all your extra expenses.
Conclusion: Last but not the least, emergency can come anywhere, anytime with anybody. So, we never know when we will need the contingency fund. Better to check your extra expenses and keep saving money for your emergency along with the future. Spend your money only when you need to. Don’t just splurge your money by buying unwanted things and shopping. Try to adjust the lifestyle by cutting down extra expenses. Remember, it is not the money that matters, it’s how you use it that determines it’s true value!
(Disclaimer: This article is only for information purposes. Investors should seek experts' advise before parking money in any fund or scheme)
