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How to rebuild a depleted emergency fund

If you had used your emergency fund in this pandemic, work towards rebuilding it back to its original levels. Here are the steps.

It’s a great relief to have the cushion of an emergency fund in times of crisis. You can fall back on it whenever life throws a surprise at you. The current pandemic has many stories of a family’s emergency fund getting completely wiped out. 

Having an emergency fund helps one stay afloat financially - without becoming indebted or compromising one’s basic lifestyle. 

Let’s understand, first of all, an emergency fund.

What is an emergency fund?

It is a contingency fund one dips into in case of crisis situations like that of a job loss, medical emergency or something that impacts the community at large such as wars or a pandemic like the current one.

If you had used your emergency fund in this pandemic, work towards rebuilding it back to its original levels.

Here are the steps:

Make a goal 

First of all, arrive at a target emergency fund amount and the time frame within which you plan to achieve it. Usually, about four to six months of essential household expenses are recommended as an emergency fund. All expenses that are essential to maintain your basic lifestyle are part of it. It includes rent, food & groceries, utility bills, school feels as well as home loan EMIs and insurance premiums. 

If there is a new family member or you upgrade your lifestyle, your emergency funds need to reflect the proportionate change in expenses. Usually, a household with children and a single income can park more (up to 12 months of expenses) than otherwise. Once a target amount is arrived at, work out a time frame (say 1-2 years) and thereby the monthly savings needed to achieve it.

Start budgeting

If you have not yet started the process of budgeting, do it now. Categorize your expenses into various heads such as housing, utilities, food, transportation, and savings, and so on. 

Pull up your credit card and bank statements to enlist all the expenses into these categories. Then, convert absolute expenses into budget percentages and compare it with the recommended budget percentages. It will indicate which expenses are off-the-limits, while also letting you know how much you save currently. 

Recently, got a tax refund or bonus? Instead of splurging it, channelize it towards stocking up the emergency fund. It will accelerate your progress towards the goal.

Bridge the gaps 

If you are saving Rs 30,000 every month and need to build an emergency fund of Rs 6 lakh, it will take 20 months to hit the target. To do it in 12 months, you need to save Rs 20,000 more. 

The budget gap can be bridged either by slashing unnecessary spending or by increasing your income. Try and look at one major expense which you can save on. Or perhaps curb a large portion of your discretionary spending.

Capitalize on the windfalls

Recently, got a tax refund or bonus? Instead of splurging it, channelize it towards stocking up the emergency fund. It will accelerate your progress towards the goal.

Calibrate other short-term goals

It is important to build your emergency fund first. So, put on hold your monthly contributions towards other short-term goals like buying an electronic gadget. 

However, do not compromise on your contributions towards critical long-term goals such as retirement or child’s higher education. SIPs towards these funds should continue as far as possible. If you are unable to do it, then ‘pause’ it till you achieve the target for the emergency fund. 

Automate saving

Make saving a regular habit and also a daily, weekly or a monthly ritual. Ensure you invest as soon as you get your pay cheque or your business income so that you save before you start spending. Automate the investing process through a direct debit from your bank account so that you don’t skip any contributions. 

Park safely

Security, accessibility, and liquidity are three important requirements of an emergency fund. Timely and quick access to your emergency fund is critical as most emergencies strike fast. Moreover, it needs to be deployed in investments which have absolutely no risk of capital erosion in the short term.

On this count, short-term debt funds – liquid and ultra-short-term debt funds – fits the bill as against the traditional saving instruments like that of bank fixed deposits or a National Saving Certificate. By investing in the former, not only is your capital nearly safe and highly liquid, but you also earn better post-tax returns. 

Takeaway

Replenishing your emergency fund should be your first priority, once things get back to normal. Cut unnecessary spending and recalibrate your short-term goals to save for the rainy day. 

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