What is an emergency fund, and why you need one?

Everyone needs an emergency fund. I learned that lesson the hard way. For instance, my prolonged health issues requiring multiple surgeries and frequent hospitalization taught me about the emergency fund. Please do not learn that hard way. Life is too short to live it and learn through experience. You must take the lessons from others and implement them in your life as soon as possible.

You must have heard the story of ‘the ant and the grasshopper‘. The grasshopper was so busy singing and making music that it forgot to store food for the winter. It happens with us also. In the hustle-bustle of our life, we forget to save something for those rainy days. This lesson reminds you of your responsibilities to save money for those unforeseen circumstances. 

What is an emergency fund?

An emergency fund is a readily available liquid cash (cash-in-hand, cash in saving accounts, liquid funds, etc.). It helps you meet your financial emergencies like unexpected health issues, job loss, a sudden house or car maintenance, natural disaster, etc. In other words, the cash we keep to meet our emergency needs is called ’emergency funds.’ 

You have some planned expenses and some unplanned. Planned expenses maybe your monthly utility bills, education fees, fuel, and transport expenses. On the other hand, some unforeseen expenses like your car or bike requiring sudden maintenance. The emergency fund sits well with those unplanned expenses.

An emergency is an emergency. It does not knock at the door to enter your house. Therefore, you must be prepared to encounter it once it comes. A few people are taking the necessary precaution and keep an emergency fund. Others either don’t have an idea about it or are careless about it. As life is full of surprises, let’s be smart and plan for it.

What is the right time to start an emergency fund?

The best time was yesterday, and if you have missed it, then today is the right time to plan for your emergency fund. There is an old saying in Sanskrit‘Shubhasya shighram, ashubhasya kalaharanam‘ that means that when we have a good desire, we should start it as soon as possible unless the evil power will supersede us and stand as an obstacle. It is true for most of us.

Some people might argue that they are in debt or financial problems and have nothing at the end of the month to save. They may be right. However, emergencies can still knock on your doors, which may be the worst thing you can ever imagine. Therefore, you have to save for your distress, and there is no other way. Remember, an emergency fund builds your confidence to face any financial situation and provides you peace of mind.

Some of you might think that you have some bank fixed deposits, mutual fund unit, stocks, insurance papers, retirement account, and other sources of cash that you can deploy whenever such things happen. However, you must remember that those investments must have a goal attached to it. You might not be able to redeem it as fast as you need the money. Besides, it may not be tax-friendly.

I have observed a lot of people prefer to invest their money than maintaining an emergency fund. They argue that they can make more money by investing than keeping their money sitting ideal in a saving account. They may correct to some extend. However, such decisions can be fatal when an emergency occurs at the wrong time, and they have to book a loss in their investment to meet their emergencies.

How much money you have to keep in the emergency fund?

You must keep at least six months of living expenses in an emergency fund. By living expenses, I mean all your household expenses, including loan payments. Some expenses may not occur every month; instead, they are your yearly expenses like hosting, insurance, or other subscription expenses. You have to calculate all those expenses while calculating the required amount to save as your emergency fund.

If your living expenses come to a figure close to Rs 50,000, then you have to multiply it by six to get the number (50,000*6=3,00,000). It is just an example. Your actual expense may go in both directions. However, the problem with this calculation is that the financial conditions of each family are different. There are families where both the husband and wife are earning, and they don’t have any other responsibilities. Then, they may manage with only three months of their living expenses. On the other hand, there are families where there is a single bread-earner, and many family members, including elderly persons, are dependent. In those cases, that person must have to keep at least 12 months living expenses (here I assume that they have sufficient medical and other insurance).

To conclude, it is better to have an extra cushion and go the extra mile in the case of an emergency fund. Therefore, a one-year living expense kept in an emergency fund is an ideal formula.

Where should you keep your emergency fund?

An emergency fund should be out of your sight. Most of the people cannot resist not to touch it at minor requirements. Once, a small problem arises, they tend to use it up. Therefore, there is a chance that you will end up your emergency fund buying something ridiculous. That’s why it should be away from your sight. Once it is out of sight, you forget about it slowly, and your brain will not tempt you to exhaust it. It may seem some psychological disorder, but believe me, it happens.

Banks 

To keep it away, you may apply for a second bank account with a reasonable interest rate and save your money there. As it becomes your secondary account, you need not have to visit it (online or offline) frequently. That is the first option. The second option is to keep it in bank fixed deposits. Today, you need not have to visit a branch to open a fixed deposit account. You can do it online easily within a few steps. That way, the money will not sit in your savings account to lure you. In case of an emergency, you can also redeem it instantly to meet your expenses.

Mutual Funds

Another exciting place to keep your money is in liquid funds. It is a mutual fund where a fund manager invests your money in money market instruments like treasury bills, Certificates of Deposit, Commercial papers, Term deposits, etc. You can get a good return and even sometimes better than bank FDs. As the name suggests, they are liquid investments, and so can be redeemed easily. However, you have to scan a few security parameters before jumping into a liquid fund.

The overnight fund is another exciting place to keep your emergency fund. It is less risky than liquid funds and therefore comes with less return. However, you will earn a better return than a savings account.

Remember, the purpose of an emergency fund is to meet your financial emergencies, and it can happen anytime. Therefore, your must-have investment features include liquidity, safety, and user-friendly operations (preferably an online mode).

Conclusion

People don’t start their long term investments in fear of the emergency that might occur during their investment period. They don’t know how they will handle an emergency if they block their money for the long term. That fear holds them back, and they never invest. It is a genuine argument. The simple solution to the problem is to create an emergency fund. It is a friend in need. Don’t worry if you have not built one. It may take time, especially if you are struggling with day-to-day living expenses. However, your decision to create an emergency fund is the first step towards your goal.

I hope you will take care of yourself and your family members by building an emergency fund. Share your views, ideas, or any experience (if any) to help others.

I would appreciate your views, comments, and suggestions.

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3 thoughts on “What is an emergency fund, and why you need one?”

    • You must keep at least six months of living expenses in an emergency fund. By living expenses, I mean all your household expenses, including loan payments. Some expenses may not occur on a monthly basis, rather they are grouped in your yearly expenses like your hosting, insurance, or other subscription expenses. You have to calculate all those expenses while calculating the required amount to save as your emergency fund.

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