Ensure you’re ready for life’s surprises by establishing a reliable emergency fund. In this enlightening blog post, you’ll learn how to create and strengthen your financial safety net, providing you with peace of mind for whatever challenges lie ahead.
The Context
Having a separate fund for the things in life that happen, helps keep the emergency fund intact in case you lose your job or income — Michelle Singletary
If our life were represented by a line graph, it would resemble a price chart from the stock market.
Numerous waves of high points, panics, sideways movements, and low points or crashes would occur. It is hence crucial to make good plans for life’s eventualities in the same way that we manage market volatility. An emergency fund is a financial safety net that helps you get through tough times. Its primary function is to serve as “Plan B” in the literal sense, for dealing with inevitably unanticipated circumstances.
According to a recent analysis by the Mint. In the year ending March 31, 2022, Indian households’ savings decreased to the lowest level in the previous five years. As inflation reduced the purchasing power, people used their money to go on “revenge spending,” feeling their livelihood was safe. The gross financial savings of households decreased to 10.8% percent in the fiscal year FY-2022 from 15.9% percent in FY-2021. It was 12% during the three preceding fiscal years.
This situation appears a little unsettling given that recent winds have once more suggested that a recession could be on the horizon.
Are you ready for the worst-case scenario?
An emergency fund makes it easier to deal with many of the uncertainties that must be considered while developing a financial security strategy. In this comprehensive how-to manual, let’s get into the specifics of how to create an emergency fund.
What Is an Emergency Fund?
Medical crises are frequently thought of as emergencies, although the term “financial emergency” actually refers to any unanticipated expense that is not planned for in your day-to-day budget.
This can involve an urgent house repair, a car breakdown, an unexpected trip, or even a job termination.
Many Indians live hand to mouth due to their limited financial resources and lack of financial skills.
The phrase “living hand to mouth“ has its roots in the 1500s and refers to those who are exceedingly needy and have only enough money each month to cover the most basic needs, such as food and shelter.
Hence, before settling in for that carefree lifestyle, it is crucial for those seeking growth and prosperity to break this pattern and ensure they have some readily available cash.
Benefits Of Having An Emergency Fund
1. Less Anxiety
Having an emergency fund has many advantages, but the main one is reduced anxiety. Even though you may have never considered it in this manner, every day, all humans accumulate serious risks.
This complex equation includes elements such as operating appliances, using busy roads, handling sharp objects, food and lifestyle choices, work performance, and economic conditions. Many of these risks can be mellowed out to a great extent by having an emergency fund.
2. Helps Avoid Predatory Lending
Emergencies necessitate rapid financial requirements and prove to be the weakest occasions where rationality is thrown out the window. If you have an emergency fund, your chances of taking out high-interest personal loans, selling off family antiques for pennies, or engaging in dangerous behavior are greatly reduced.
3. Promotes Savings Behaviour
Having an emergency fund promotes saving habits. Being confident in one’s safety can curb the desire to purchase luxuries and nonessential consumables such as expensive watches, designer clothing, or compulsive purchases like Starbucks’ Duo Cocoa Mocha Frappuccino @ ₹399/- plus taxes.
Characteristics Of Emergency Fund
Liquidity is a crucial component of an emergency reserve. Your capacity to exchange an asset for cash without suffering a significant value loss is referred to as liquidity.
An asset is more liquid if it is simpler to turn it into cash.
It wouldn’t make sense to keep your emergency fund in term deposits, or a piece of land and expect you could swiftly sell it off in an emergency. Lack of ability to generate profits is another important quality of an emergency fund.
This is consistent with the axiom that the lower the risk, the lower the return in the world of investments. In the case of an emergency fund, you may wish to carefully consider keeping your risks at a minimum and accepting average or lower returns.
Even though this fund can be kept in a bank account for short or extended periods, do not expect profits from your emergency fund because it may not be able to fulfill its intended function when the time comes.
How To Build One?
The amount you should put aside for emergencies will depend on your lifestyle, monthly expenses, income, and dependents. However, as a general rule, you should save enough money to cover your expenses for three to six months. This sum can initially seem intimidating, hence further clarify this thumb rule, here’s some direct guidance:
🖱 Young people in their 20s and 30s should start by setting aside money for at least three months’ worth of monthly expenses.
This should be gradually increased to four, five, and six months once the desired level has been reached.
🖱 Aged 30 to 40-year-olds should immediately try to secure six months’ worth of expenses.
This sum should be reviewed and adjusted for up to nine months in light of the individual’s current health conditions, the security of their jobs, their children, their obligations to pay debts, and the state of the economy.
Capping superfluous monthly expenses (like ₹399 Duo Cocoa Mocha Frappuccino) from your budget is another clever way to accumulate a 9-month emergency fund.
🖱 New businesses and freelancers should strive to secure at least 9 to 12 months’ worth of costs.
Having a greater sense of security encourages taking calculated risks to succeed given considerations like seasonality and competitiveness of free work. Even though this may seem like a challenging feat, your aim should be to save a tiny sum every week or month for a manageable amount of time to achieve your goal.
Where To Park Emergency Fund?
The purpose of keeping an emergency fund is to have access to it quickly. The ideal place to keep emergency funds is in simple interest-bearing investments like fixed deposits or secure money market funds.
Make sure they don’t incur excessive taxes or penalties upon liquidation.
Some Available options in India are Fixed Deposits, Short Term Debt Funds, High-interest Bank Accounts, Gold ETFs, and Post office saving schemes. As the main enemy of your emergency stash is inflation, the ideal strategy to take advantage of variable interest rates and safety from these alternatives is to divide or ladder your emergency fund over 2-3 options according to your financial understanding.
Conclusion
An emergency fund is not an investment. It must be seen as a separate savings or bank account used to defray or pay for unforeseen situations. It shouldn’t be viewed as a retirement nest egg or included in a long-term savings strategy for paying for college expenses, a new car, or a trip. This money is only meant to be used in an emergency and is meant to be locked away and forgotten for successively longer periods.
Additionally, an emergency fund needs to be re-balanced annually to reflect your shifting demands and rising or dropping monthly expenses.
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