Why Building an Emergency Fund is a Necessity?

If something that COVID-19 pandemic, taught us was having a necessity of an Emergency Fund. This event was an unanticipated one and who knows what uncertainties and emergencies are stocked for us in the near future. Having a contingency fund solves the misery of unexpected financial blows!

In this blog, we’ll be discussing some of the topics mentioned below: ? What is an emergency fund? ? What should be the size of an Emergency Fund? ? How to build an Emergency Fund? ? Where to Keep Emergency fund once accumulated?

What is an emergency fund?

In a layman’s language, an emergency fund is a fund that is set aside for emergencies. It is an amount that is kept separately from your usual expenses. This fund is specifically designed for unpredictability.

Emergencies can be of anything. Such events where death, illness, health issues, etc., can be protected by insurance. Insurance is also a form of an emergency fund. Here, you can take financial protection against your loss.

But unfortunately, not everything cannot be insured. Let's assume, you lost your job, you are struggling hard enough to search for one. But these things normally take time, as you want to avail the best opportunity. Let's say, it took you 3-4 months searching for another job, now your monthly expenses have to be paid, but the question is how do you do this?

Well, this is where the necessity of having an emergency fund is realized. I’m sure many of you might think of taking a loan as an option from someone, but in the end, you have to pay that amount too!

What should be the size of an Emergency Fund?

The general advice that every financial planner/advisor says, is to have an emergency fund for a minimum of 6 months and a maximum of 12 months. This might sound a bit too much to hear, but is not!

For people in their 30s, 40s or say 50s, financial stability is more as they have some financial cushion secured that might be in the form of investments too! They might have some financial plan going on!

In your 20s, you are just starting to take off your career, your job, and financial stability are not secure. Your monthly salary might be within the bracket of 20k-30k. And God forbid, any major expense comes your way, how will you arrange it then? Well, let's learn that in the next section.

How to build an Emergency Fund?

Building an emergency fund requires patience and most importantly, discipline! To know how much you need to build an emergency fund is to multiply your monthly expenses into 6, for 6 months and 12, for 12 months.

Considering the previous scenario, where your salary is let's say, 25,000 per month. Out of which, 8,000 is your rent, 4,000 is for utilities, 2,500 for any EMI’s, Personal expense is of 5,000 and investment is of 5,500. Now calculating your needs, your necessity expense is 14,500. Considering a minimum 6 months emergency fund, you’ll be needing 87,000 and for 12 months, Rs. 1,74,000 of emergency corpus.

This is how to calculate your requirement for Emergency corpus. Your needs, are things that you can't say no to, and eventually, it's like a routine payment for each month. Your wants will be your personal expenses, desires like dining in, purchasing new clothes, gadgets, etc. These are things that you can easily live off for a while. You should focus on zeroing down your desires and focus on building your fund first.

Where to Keep Emergency fund once accumulated?

This is the most important part. Once you have been successful in accumulating your emergency fund, or in the middle of it, where should you keep your emergency fund?

There are 3 major components to follow here. Considering 6 months of accumulated amount lets see the distribution of 87,000:

The reason behind putting the major amount in Liquid Mutual Funds is that it has 3 benefits: ? Unlike other investment options, there is no exit load (penalty)to withdraw money ? The money, after selling Liquid Mutual Fund is received within 24 hours ? It provides returns somewhere between 5-7%, slightly better than FDs.

Bottom Line:

Having an emergency fund is very crucial, the process is easy to feel but is hard to implement. But with discipline, it can be achieved. Also, make sure to not put your emergency fund in any form of risk. This fund is solely designed for unpredictability and not for investing in stocks, gold, or real estate.