A Beginner's Guide to Emergency Funds

Life is full of surprises, and sometimes these surprises come in the form of unexpected events that can have a drastic effect on our routines. Whether it's a sudden health issue, a job loss, or an unforeseen economic dip affecting your income, such events are beyond our control. However, what we can control is how much prepared we are to face them. And, the solution lies in the concept of building an Emergency Fund. 

These funds act as your support system during challenging times and offer a buffer to help you manage your essential expenses. So, let's go through this post and understand the importance of creating and maintaining this emergency fund.

What is an Emergency Fund?

An emergency fund is like your financial safety plan that is there to help you keep going with your regular life. Not only this but the emergency fund also covers life's unexpected expenses without letting you resort to last-minute loans, maxing out your credit card, or selling off your personal assets.

While setting up your emergency fund, you must take into consideration your must-pay bills i.e. the ones you absolutely cannot skip. Please note that everyone's essentials might be a bit different, though. 

The key is to make sure you've got enough money saved as an emergency fund to handle your critical expenses, whatever they might be.

Advantages of Having an Emergency Fund

Following are the top 5 advantages of having an emergency fund:

1. Financial Safety: An emergency fund acts like your safety net and provides you a financial aid when unexpected expenses arise. 

2. Peace of Mind: Knowing that you have an emergency fund set aside brings peace of mind. It moreover reduces anxiety about how you will cover sudden costs, thus helping you focus on your daily life without constant financial worry.

3. Flexibility in Decision-Making: With an emergency fund, you have the flexibility to make better decisions. Whether you are experiencing a job change or unexpected bills, having savings will allow you to navigate life changes without feeling trapped.

4. Swift Response to Opportunities: Having funds readily available enables you to grab unexpected opportunities. In other words,  your emergency fund becomes a tool for taking advantage of favorable situations.

5. Encourages Financial Discipline: Building and maintaining an emergency fund encourages financial discipline and instills a habit of saving. 

Strategies to Establish Your Emergency Fund

Following are the five simple strategies that can help you build an emergency fund without any hassle:

• Break It Down into Smaller Goals: Rather than aiming for the full three or six months income right away,  make sure you set smaller and achievable targets. This can be achieved by beginning with a week or even two weeks. Reaching these little objectives will encourage you to keep going and eventually help you reach bigger objectives.

• Automate Your Savings: Another thing that can help you with building an emergency fund is by automating your savings. This can easily be done by setting up automatic deposits. Furthermore, you can create a dedicated emergency fund account and watch your funds grow. But ensure you choose an account that isn't easily accessible, and this way you will allow time to show its magic. 

• Avoid Lifestyle Inflation: Once your saving becomes automated, it's important for you to resist the willingness to increase your spending. This implies that instead of spending any remaining funds on items that aren't really necessary, think about putting it into savings. 

• Know When to Stop: Last but not least, one should know when to stop. An emergency fund should always be readily available and must be kept in low-yield options like savings accounts. But make sure you don't over-save in an account with minimal interest gains.

Determining the Ideal Size for Your Emergency Fund

Having some savings set aside for unforeseen circumstances is always a smart idea, irrespective of how much money you make or spend. The standard guideline for "How much do I need in it" is between three and six months worth of your monthly income. 

This can be better understood with the help of an example. If you earn Rs.40,000 a month and spend Rs.18,000 on your day-to-day expenses, your emergency fund should be between Rs.1,20,000 to Rs.2,40,000. 

Not only that, but you can divide your emergency savings into Long-term Funds and Short-term Funds. 

• Long-term Emergency Fund

This type of emergency fund is for major emergencies like a  disaster or a sudden serious health issue.  Make sure you invest this part of your fund in things that earn high interest, even if it might take a few days to get the money.

• Short-term Emergency Fund

The short-term fund is for smaller emergencies where you might need quick access to cash. Though this type of fund won't earn much interest, you can get the money right away. This fund can help in really urgent situations until you can access your long-term emergency savings. 

Choosing the Right Place to Safeguard Your Emergency Funds

Once you have decided how much money you wish to save for emergencies, the next step is to figure out where to keep it. A Savings Account is a fantastic option for this because it allows you to access your money fast. Finding a savings account without any fees or a minimum balance requirement is crucial, though. 

However, since you won't use your emergency fund on a daily basis, you can put some of it into Investments that give you a combination of easy access and better returns than a regular savings account.

Moreover, certain Mutual Funds do the same thing. They let you get your money back easily and often give you more return on your investment (usually between 6% and 8%). 

Should the Emergency Fund be Kept Liquid?

Yes, it's highly advisable that one should always keep emergency funds liquid i.e. easily accessible. The idea behind this is to make sure you can seamlessly handle unexpected costs and expenses. 

And, when you choose where to keep your emergency fund, being able to get your hands on the money quickly is super significant as you would obviously want to be able to withdraw it without any hassle or waiting. Also, you should always be careful not to get hit with additional fees for exit loads or pre-withdrawal penalties. 

Conclusion

An emergency fund is not just about money but also about peace of mind and being ready for anything, and everything. And, by following the strategies outlined above, you can easily build and maintain a robust emergency fund that will surely offer a secure foundation for your financial well-being.

Frequently Asked Questions (FAQs)

Q 1. Why do I need it?

Ans. Having an emergency fund acts as a financial safety net and offers assistance when unexpected expenses arise. It even brings peace of mind and reduces anxiety about covering sudden costs.

Q 2. Should I split my emergency fund?

Ans. Yes, one must always consider dividing emergency funds into long-term and short-term funds, where long-term funds are for major emergencies and should be invested for high interest and short-term funds are for quick access in smaller emergencies.

Q 3. Where should I keep my emergency fund?

Ans. A savings account is always a good choice if you wish to have quick access to your funds. You can even consider investments and certain Mutual Funds for better returns.