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What is an Emergency Fund?

 ‘Life is unpredictable; it is wise to be geared up for what’s coming good or bad’

Kishor, one of my friend is really struggling to keep up with his life as he lost his job in Corona crises. He do not have enough funds to pay the bear the daily expenses and pay EMI’s.  

If Kishor, would have arranged enough Emergency Fund he could have easily managed until he gets a new work. 

What is an Emergency Fund?

A certain amount kept aside to battle with emergency situations like a leaky roof, paycheck cutoff, medical emergencies, car maintenance etc. is called as Emergency Fund. Basically, an Emergency Fund is cash spared to cater for unforeseen events which may disturb our financial planning.

We must make sure that we have enough finances to stand strong against anything because people often turn backs when the time is difficult.

Why we should have an Emergency Fund?

‘To be prepared is half the victory’

                                                                                              – Miguel de Cervantes

Life is unpredictable and we never know what tragedy we may need to face tomorrow. It is a wise decision to make an arrangement for any occasions that may arise.

Corona pandemic has already stressed the importance of having an Emergency Fund. Corona crisis has made many of us lose jobs. Many folks are struggling to get their lives back on track after the crisis. Emergency Funds are very useful in such scenarios.

Junk food, lack of exercise, modern lifestyle is causing many health troubles. We may need to rush to hospitals at any time. Apart from this if we have oldies at home; we always need to be prepared for medical emergencies with ample cash. The same goes for kids, as they need intense care.

Having an Emergency Fund is really handy in unforeseen events like car upkeep and minor car accidents as well.  Vehicles are high-priced these days so the repairs.

Some of the home appliances require considerable repair costs. If you have pets at home they also need care.

If you give it thought all of these things are unpredictable and require significant costs. It will be insightful to have a fund to fight with these events hence building an Emergency Fund is one of the primary steps in planning personal finances.

What are the benefits of Emergency Funds?

‘Nothing helps you sleep better at night than knowing you have money tucked away for an emergency’     

                                                                                  -Greg McBride

  1. No more loans

You do not need to borrow cash if you have Emergency Funds in the place. Loans in such situation are not at all productive and come with interest to pay along the processing fees. Apart from that, you have to go through all the hassle to get the loan approved by the bank.  

  1. Peace of mind

Having an Emergency Fund to rely upon allows you to sleep without worry. It also prevents panic during contingencies.

  1. Self Esteem

‘Prepare yourself for a bad time when the time is good.’

You neither have to seek help from other people nor have to face the refusal of help. It hurts when people turn back on you in bad times.   

  1. Enough availability of funds in emergencies.

Emergency Funds ensure the availability of adequate funds as it is decided based on the necessities.

  1. Grab an opportunity

Some time Emergency Funds comes in very handily to grab unexpected opportunities like having a discounted deal on a car, bike, property, etc

Though Emergency Fund is not dedicated to be used for such investments sometimes it is very beneficial to take chances.

Emergency Funds should not use frequently for other purposes as they are not meant to be used for investments or pointless spending and should be configured back after utilization as soon as possible.

How much money should we have in our Emergency Fund?

Finance planners recommend Emergency Fund equals to 6 month’s necessary expenses. If you have a secured job then 3 month’s Emergency Fund may be enough but if you do not have a promising job you should have at least 6 month’s expenses kept aside.

What are the examples of necessary expenses?

Following expenses that can be included in Emergency Fund:

  1. Electricity bills
  2. Water bills
  3. Phone and internet bills
  4. Groceries cost
  5. Food: Milk,  
  6. Insurance premium.
  7. Loan EMI.
  8. Regular medical expenses.
  9. Educational expenses, school, and tuition fees.
  10. Home rent, etc

How do you build an Emergency Fund?

  1. Make a list of all the necessary expenses and costs involved.
  2. Decide the period for which the emergency fund is created viz. 3 months, 6 months.
  3. Calculate the lump sum that would be considered as an Emergency Fund.
  4. Decide the period required for saving the desired Fund.
  5. Select the instrument to park the funds. Ex. Saving Account, Fixed Deposit, Liquid Funds.
  6. We need to keep updating our funds with time. Like if there is a little one to come in the family it is going to raise the monthly expenses, as we grow old we need various medical aids to living, etc.  

Now, we can start sparing some amount by the end of the month to create the Emergency Fund. We should arrange the funds as soon as possible because emergencies come with no warning bell.  

How do I calculate my emergency fund?

What are the features of an Emergency Fund Plan?

  1. Availability of adequate funds.

The Emergency Fund should be adequate for your needs in emergencies. The thumb rule of Emergency Fund says you should have 6 months’ expenses kept aside.

  1. High Liquidity.

The funds kept aside should be liquid enough. Liquidity refers to converting the financial instruments to cash.

  1. Decent returns.

The Emergency Fund should generate decent returns to fight inflation. If we do not park the funds at the place where they can generate returns, the fund is going to become useless as inflation is rising so fast.

  1. Easy accessibility

The funds should be easily accessible. If we park funds in a bank account or liquid funds they can be easily accessible through internet banking or digital payment methods.  

  1. Economical

We lose returns if we break an FD. We also need to pay penalties if we pull back within 7 days from the liquid funds. We should focus on parking the funds in such a way that we do not have to pay penal charges for withdrawing the funds. 

Where should I put my emergency money?

We can make two categories as follows before parking funds:

  • Short Term
  • Long term

The following are some of the options to park Emergency Funds.

  1. Savings Account.
  2. Fixed Deposit Account.
  3. Recurring Deposit Account.
  4. Liquid Funds.

It is advisable to park the funds diversified to avoid to ensure safety, better returns and easy accessibility. Short term funds can be parked in savings account

I plan to park 20% of my emergency fund in Saving Account, 40% in an FD and 40% in Liquid Funds.  If you plan to keep all the Fund in FD, I recommend having multiple FD accounts to avoid the penal charges while breaking an FD in case of Emergencies. Here is more information about FD.

What should the Emergency Fund be used for?

We should create strict guidelines for using the Emergency Fund. Following are some of the scenarios when we can fall back on Emergency Fund.

  1. Medical Emergencies, health issues, or sickness.
  2. Carry out daily expenses while switching jobs.
  3. Unplanned house maintenance viz. leaky roof, plumbing, electricity failures, etc
  4. Heavy maintenance of the car.

I don’t think it’s a good idea to use emergency funds for giving an expensive gift to wife when she looks disastrous !!!

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