An emergency can knock on your door anytime. It can be a job loss, or a medical emergency, or even a natural disaster leading to loss of shelter and livelihood. In an emergency, only money can be a saviour. Hence, it is better to be prepared than to repent later. Start building your emergency fund today if you haven’t already.
What is an Emergency Fund?
No one can predict an emergency. And all emergencies tend to require money. Be it a happy accident or an unfortunate event; one definitely needs money for any unexpected situation. In instances like these, being financially prepared is a must. To be financially independent in such situations, creating an emergency fund is essential.
An emergency fund is the money that is set aside so it can be used during uncertain situations. It acts as a safety net during job loss, medical emergency, or unexpected expenses. Also, this fund eliminates the need of taking unnecessary debts at high-interest rates or force you to redeem your long-term investments.
Best Place to Keep Your Emergency Fund
|Fixed Deposit||2.5%-6.5% p.a.|
|Recurring Deposit||3%-6.5% p.a.|
|Flexi Deposit||2-5% p.a.|
|Government Bonds||2.5% – 7% p.a.|
|High-yield Savings Accounts||2.5% – 5% p.a.|
|Short Term Funds||Market Linked|
|Post Office Savings Account||4% p.a.|
As the name suggests, an emergency fund is created to address your emergencies. As a result, it gives you peace of mind with your financial situation.
- Reduce the impact of unemployment: Having this fund as a cushion will help you in times of job layoffs. No income days without a cushion to fall back on can be a nightmare for any family. This fund that can cover your expenses for a period of three to six months can help you through your unemployment days.
- Medical Expenses: Having this fund will come in handy during any medical crisis. Medical care expenses are something that we cannot plan for. Therefore, having a fund that can take care of your medical expenses is a blessing in disguise.
- Unforeseen Expenses: Unforeseen expenses can often burden you. For instance, natural disasters, major home repairs, major vehicle repairs, unplanned travels and events, etc. These can be a hefty expense on your pockets. This fund can help you pay for a part or maybe can fully cover your unplanned expenses.
How to Create an Emergency Fund?
Building an emergency fund and determining the corpus can be a task. Most of us get nervous and do not end up doing the job right. However, the following simple steps will help you build this fund:
- Have a deadline to create the emergency fund: Working on deadlines is often productive. Therefore, to achieve your goal, have a deadline and mobilise funds to achieve it. It can be three months or six months, or one year, on the basis of your financial position; set up a deadline and start your investments.
- Evaluate your assets: You can use some of your existing assets/ investments to start building your contingency fund. Any extra cash in your bank account can be a good start for the fund.
- Compute your monthly commitment: Estimate the shortfall amount based on your corpus requirements and existing cash position. On the basis of your requirement, calculate the monthly contribution that you have to make towards building the corpus.
- Separate your emergency fund investments from your other investments: Do not mix your investments. Strictly keep your emergency investments separate. No matter what, do not stop your investments or withdraw money for unnecessary expenses.
- Any lump-sum amounts should be channelised into your emergency fund. For instance, a year-end bonus or a sales incentive or a Diwali gift from your parents. Invest the lump sum amount in your fund to create a good corpus faster.
How to Calculate Emergency Fund?
To calculate how much you should save for an emergency, you should estimate your monthly income and expenses, including rent, maintenance, EMIs, bills, travel and entertainment expenses. Once you determine these expenses, rate from low to high the chances of you losing your job and getting a new one. If the risk of losing a job is high and chances of getting a new job is low, then you will need to build a fund that will support you for at least one year. Multiply your monthly income/expenses (whichever is higher) with 12 to estimate how much should your contingency fund have.
Plan your fund with Scripbox Emergency Money that help you determine how much you should have in your emergency fund.
How Much Should You Invest in an Emergency Fund?
There is no definite figure for how much you should invest in this fund. Like your investment portfolio, this fund has to be custom made. However, the strategy that you deploy to create the fund can be more or less the same. Ideally, most experts in the industry suggest an emergency fund worth at least three to six months of your expenses.
Aim for a starter emergency corpus, and then work your way up towards a long-term plan. Therefore, you can plan for a short-term and a long-term emergency fund.
- Short term emergency fund: A short term emergency fund should ideally focus on liquidity. To elaborate, in case of emergencies, you should be able to liquidate your investments without any delay quickly. Savings/Bank account, Short Term FD and Liquid Funds can be good options for creating a short-term fund. Therefore, focus on immediate accessibility. Your short-term fund should help you meet your needs till you can access your long-term funds. Find out best short term investment plans
- Long term emergency fund: Long-term funds can be created to generate higher returns in the long term. Large scale emergencies may well require a large corpus. Therefore, investing for the long term can help you generate higher returns. Liquid Funds and Long-Term FD may help you create a significant corpus over time. Medical emergencies or unforeseen emergencies can often demand higher amounts. Therefore, having a significant corpus will help you in such situations. Find out best long term investment plans
When to Redeem Emergency Fund Investment
You can redeem your emergency fund when you have no disposable income in hand, or there is an unexpected expense that requires additional money. Moreover, you can also redeem the fund when you lose your job or face a medical crisis.
Ensure that your fund is parked in different avenues so you can access your funds quickly when necessary. This is mainly because certain investments have a limit on the amount that can be withdrawn in a single day. So, by spreading your investments across multiple avenues, you can redeem more funds quickly.
Frequently Asked Questions
An emergency fund is money set aside for the purpose of any emergency. This fund will help meet unexpected expenses like house repairs, medical emergencies, etc. Moreover, this fund is very useful as it eliminates the need of taking a loan at interest rates during any emergency. A minimum of 6 months income should be set aside for this fund. And you can park this in cash, savings account, and liquid funds.
A short-term emergency fund is a fund that is easily accessible and will support all your immediate emergencies. You can use this fund for all your unexpected emergencies until you can access your long-term emergency fund. Though the interest rate offered by short term fund investments is low, they rank high in terms of liquidity.
A long-term emergency fund is the one that helps you create a larger corpus to meet large scale emergencies. In other words, through this fund, you should aim to meet your medical expenses and other unforeseen expenses that can be heavy on your pocket. You can create a long-term fund by investing in slightly long-term plans that will help you generate significant returns. Though they might not be highly liquid, your primary motive is to create a large corpus.
The amount you should have in your emergency fund largely depends on your lifestyle and income levels. Ideally, you should aim to create a fund that will cover at least three to six months of your expenses. In other words, no income days or unforeseen expenses can be unpleasant. To save yourself from such experience, create a good corpus. Analyse your income and expenses, create a budget plan and identify how much you would require to survive at least three to six months without any income.
An emergency fund can be both short and long term. A short-term fund is one that is highly liquid and easily accessible. Some of the best short-term avenues for short term funds are cash, savings bank account, liquid funds and short-term FDs. However, the interest rates are on the lower end for these investments. A long-term emergency fund gives a higher interest rate but ranks low on liquidity. You can invest in FDs with a tenure of up to 5 years for building a long-term fund but remember that this does not satisfy the need for liquidity which is important in an emergency fund.