Copy of What is an Emergency Fund, and how do you save for it?

See how having a savings buffer can reduce stress, keep you out of debt, and help you handle life’s surprises.

You may have already considered big-ticket items like your retirement or your children’s education and marriage, but are you among the 25% of Indians who have saved for emergencies?

According to a survey, 75% of Indians don’t know what to do in case of an emergency like a broken fridge at the peak of summer, an unexpected job loss, or another pandemic.

Don’t worry! With the proper steps, you can save enough in your emergency fund when life throws curveballs towards you.

Emergency Fund – Your Best Friend

An emergency fund is a temporary safety net in troubled times. Think of it as a fund that gives you breathing room and saves you from financial shock during crises.  

The most common reasons that you might rely on an emergency fund are:

• Job loss

• Medical or dental emergency

• Unexpected home repairs

• Car issues

• Unplanned travel expenses

  
  

Now, because you have an emergency fund, it helps keep your stress level down. It gives you the confidence to tackle unexpected events. It also saves you from going into debt traps. In crises, there may be other ways to access cash quickly, like loans or credit cards, but at what cost? Interest, fees, and penalties are ways to fall into debt.

How Much Should You Save in an Emergency Fund?

To figure out how much you need to save in an emergency fund, consider the following factors:

• Starter Emergency Fund: If you have debt, like a credit card or personal loans, you should start by saving about ₹25,000 in a separate savings account. This is a general rule of thumb for a starter emergency fund, and even though it doesn’t seem like a big amount, it can help you during small, unexpected emergencies while paying off your debt.

• Fully Funded Emergency Fund: When you don’t have any more debts to pay off (except a home loan), you should have six to nine months of your living expenses (house rent, food, insurance, electricity, transportation, debt repayment).

Emergency Fund: Six or Nine Months?

Six Months of Emergency Fund: 

Save a minimum of six months if:

• You are single with a stable income.

• If you are married and both you and your partner have steady incomes.

Nine Months of Emergency Fund: 

Save a minimum of nine months if:

• You are married with a single income.

• You are a single parent.

• You work a seasonal job.

• You have an irregular income.

How To Save for an Emergency Fund?

If you feel stressed by the amount you have to save, here are a few steps you can take:

1. Have smaller saving goals: To begin your journey, think of saving for one month or two weeks. No matter your saving goals, make them realistic. Make sure that this amount doesn’t disrupt your living expenses.

2. Regular contributions: You need to consistently put money away in your emergency fund. Only then will your emergency fund grow.

3. Reduce your expenses: Since you are trying to save for an emergency and put away as much as possible, cut down your monthly expenses. Check out Effective Ways of Budgeting for more tips.

4. Automate your savings: Technology is your friend. Use it. Automate your savings so you don’t have to manually put money in your emergency funds every time. This will also help you not to miss any payment dates.

5. Don’t increase your spending: Even though your savings are growing, don’t think you have a lot of money and start spending more every month. That money is for emergencies only.

6. Don’t over-save: Don't keep saving more once you have your target amount (six or nine months of emergency funds). Use the extra money you have to invest in options in the market that can give you more profits.

Where should you save the emergency fund? 

To cover unexpected expenses, emergency funds must be liquid. You should never invest or put your emergency funds in a lock-in period, as your money can get blocked. You need to be able to withdraw the money when you need it without being penalised.

You should keep your emergency funds in a safe, high-yielding savings account, which you can access immediately. 

When should you use the emergency money?

Set some guidelines for yourself on what constitutes an emergency or an unplanned expense. Ask yourself these three questions if you are confused about a situation:

1. Is it unexpected?

2. Is it necessary?

3. Is it urgent?

If you answer yes to all these questions, then you have an emergency for an emergency fund.

Bottom Line

Creating an emergency fund helps you avoid the need for extra credit or loans that might lead to debt. Opting for a credit card or a loan to cover these unexpected costs can cause your initial emergency expense to balloon due to added interest and fees.

Yet, if the need arises, don't hesitate to utilise your emergency fund. If you use what's in your emergency savings, focus on rebuilding it gradually.

Key Takeaways

1. An emergency fund is for unexpected life problems. Save anywhere from six to nine months to live comfortably without financial shocks.

2. Emergency funds must be liquid, so keep your funds in a savings account. This is not an investment but an insurance, so don’t look for higher returns on your emergency fund.

3. If your answer is yes to: is it unexpected, necessary, and urgent? Then it is a true emergency, and you should dip into your emergency fund.