What is an emergency fund, why do you need it and how to build it?

An emergency can strike us anytime and anywhere – one of the biggest life lessons that 2020 taught us through the Covid-19 pandemic. While certain natural calamities can keep you off work for a short period, there can often be occurrences, such as job loss and salary cuts, that call for emergency funds to manage the situation well.

What is an emergency fund?

While everyone hopes to not suffer from such precarious situations, it is always safer to build a savings buffer, which we know as an emergency fund. It helps ensure that your family is not under unwanted stress during challenging times.

An emergency fund is not a fund you set aside for buying a new house or a new car. It doesn’t have to be a considerable amount and varies from one person to another. It is, instead, a part of your savings you use solely when you have no other ways to generate money to suffice your day-to-day expenses.

What is an emergency fund used for?

An emergency fund is the money you keep aside for times when an emergency unsettles your day-to-day life, and you need money to do what needs to be done. Here is why you do need an emergency fund –

  • Job loss
  • Unforeseen medical expenses
  • Home repair
  • Other rare and emergency instances

What is the appropriate amount to allocate to an emergency fund?

Even though there is no proven way to measure the right amount to allocate to an emergency fund, we can follow a thumb rule – up to six months of regular expenses, including liabilities like loan repayments. It will help you meet your regular obligations while living a frugal life when the going gets tough.

How to start an emergency fund?

Here are the key steps that will help you start and build an emergency fund –

  • Look for funds lying unused and if you can allocate them to the emergency fund
  • Set a target date for your emergency fund completion
  • Decide a monthly commitment that you will put aside for emergency fund
  • Keep the contingency fund separate from other accounts
  • Allocate any incoming lump sum into the fund

When not to use an emergency fund?

It is imperative to determine what you can term as an emergency and when you can use an emergency fund to suffice your needs. Here are some examples that you should not use as an excuse to break your contingency fund –

  • A luxurious vacation
  • Buying a new machine or a gadget/device
  • Replacing your car
  • Fulfilling your dream of a destination wedding

An emergency fund is a necessity for everyone

Irrespective of how much you earn, having an emergency fund would bode well for your family’s future. You can build it by cutting down unnecessary expenses, getting a side hustle, or selling things you do not need. Another crucial thing to remember is that instead of keeping it in a savings account, you can invest it in a liquid fund to cover inflation. Explore your investment options by reaching out to a financial advisor today.

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