What is an Emergency Fund and Why you must have one in 2023?

In today’s uncertain world, having an emergency fund is crucial to financial stability. An emergency fund is a savings account set aside for unexpected expenses, such as medical bills, car repairs or job loss. It provides a safety net and peace of mind, knowing that you have a financial cushion to rely on when you need it most. In this article, we’ll take a closer look at what an emergency fund is, why it’s important, and how to build one.

What is an Emergency Fund?

An emergency fund is a savings account that is specifically set aside for unexpected expenses or financial emergencies. It is an important financial tool that can help individuals and families weather unexpected financial storms, such as a job loss, medical emergency, or natural disaster.

One of the main benefits of an emergency fund is that it provides financial security and peace of mind. Knowing that you have a source of funds to turn to in the event of an emergency can help reduce financial stress and anxiety. It can also help prevent you from having to rely on credit cards or high-interest loans to cover unexpected expenses, which can further strain your finances.

In addition to providing financial security, an emergency fund can also help you achieve your long-term financial goals. By having the fund in place, you are less likely to have to tap into your investments or retirement savings to cover unexpected expenses, which can derail your financial plans.

Emergency Fund is the fund that will help you in these emergency types of situations in your life. When you need immediate money for survival or anything else you can just feel relaxed and not worry too much. An emergency fund is that sum of money that will take out from crisis situations.

Rather you panic and get into the debt trap, Emergency Fund will give you a lifeline and buy you time.

What are the benefits of having an Emergency fund?

An emergency fund is a savings account that is specifically set aside for unexpected expenses or financial emergencies. Some of the benefits of having an emergency fund include:

1. Financial security: An emergency fund provides financial security and peace of mind knowing that you have a source of funds to turn to in the event of an unexpected financial emergency.
2. Protection against financial stress: In the event of a financial emergency, an emergency fund can help reduce financial stress and anxiety.
3. Prevention of relying on credit cards or loans: An emergency fund can help prevent you from having to rely on credit cards or high-interest loans to cover unexpected expenses, which can further strain your finances.
4. Protection of long-term financial goals: By having an emergency fund in place, you are less likely to have to tap into your investments or retirement savings to cover unexpected expenses, which can derail your financial plans.
5. Financial flexibility: An emergency fund can provide financial flexibility, allowing you to make financial decisions without the added pressure of having to cover unexpected expenses.

How much emergency fund do I need?

You don’t need a big amount as an Emergency fund! The size of your fund depends on your lifestyle, goals, and current circumstances (e.g. kids vs. no kids, owning a home vs. rent, etc.).

If you’re single, rent a home, receive a steady full-time income, and are focusing on paying off your debt fast, then you can probably look for an emergency fund of 1-2 lakhs.(assuming your monthly spend is around 25k)

On the other hand, if you own a home may be on loan, or have kids, you’ll want to aim for 3-4 lakhs as a minimum. (assuming your monthly spend is 50k)

Whatever your circumstances, aim for at least 3 to 6 months’ worth of basic living expenses — things like your rent or home loan, food, and bills. If you have dependents or are self-employed, you should consider doubling that to a 6-9 month emergency fund.

If you don’t have an emergency fund then don’t worry. Start small, start the fund right away and keep building on it until you have met your goal. The most difficult part is to start the account. Many people are ignorant of the fact that life is uncertain and anything can happen at any time!

One more key thing you need to keep in mind- First pay off your high-interest loans like credit card EMI/loans before you start an emergency fund as there is no point having it when you have a high-interest loan draining you financially!

Consider reading –  How to get out of debt in 5 steps

Where should I keep my emergency fund savings?

This is the most important thing you need to understand. Often people mix up emergency funds and investments. They end up investing all the money in stocks and high-risk instruments which defeats the purpose of having an emergency fund! at the same time, you don’t want to keep your fund as cash with you as the value of money will depreciate with time.

An emergency fund should be liquid and can be easily accessible when there is an emergency. At the same time, it shouldn’t be so easy that you get attracted to it every now and then for your small needs.

Here are some best ways to park your emergency fund:

1. Insta-redemption liquid funds
2. Flexible RD
3. Sweep-in savings bank account

The best way to build up an emergency fund is to split your fund into 2-3 parts and in 2-3 instar-redemption liquid funds which you can break instantly to get the money in your bank account in a matter of minutes.

Another way is to keep your emergency fund in liquid mutual funds with insta-redemption which will give you the money instantly when you need it.

Consider reading: what is financial planning?

When should I use my emergency fund (and when shouldn’t I)?

When deciding whether or not to dip into your emergency money, ask yourself these questions:

• Is it necessary?
• Is it really really necessary?
• Does it need to happen now?
• Did I see this coming?
• Do I have any other option where I don’t have to end up in a debt trap?

You should be able to differentiate between emergency and non-emergency situations. For example, if you have lost your phone and are in need of a new phone. you shouldn’t be breaking your emergency fund to buy that new fancy phone, instead, you should be able to adjust to this situation without having to break your emergency fund!

Here are some situations that would justify using your emergency savings:

• You get laid off from work.
• Your family member is really sick and you don’t have insurance to cover it.

Situations like these do NOT qualify for emergency fund access:

• Gifts for holidays, birthdays, and other special occasions.
• Expenses you can plan for (insurance, taxes,  etc.).
• A great deal on something you really want.
• Spontaneous trips and vacations.

These types of expenses aren’t emergencies and should be worked into your normal monthly budget. Rather than relying on your emergency savings, use sinking funds to work them into your monthly budget. Save a little each month and by the time the expense rolls around, you have the money set aside to cover it.

How to Build an Emergency Savings Fund?

Building an emergency fund is really easy if you do it right. If you don’t have an emergency fund today then anything that you save today should first go to the fund than anywhere else.

There is a famous concept of a 50-30-20 budget rule. which says:

• 50% of your earnings should go towards your needs – Like rent, home loan EMIs, etc
• 30% of your earnings should go towards your wants – like travel, entertainment, restaurant meals
• 20% of your earnings should go towards your savings – here you can start looking at your emergency fund.

If you don’t have an emergency fund at all then you should reduce your wants figure and aggressively save towards the fund.

If you are new to personal finance then don’t worry, start small and build on it. Putting the first few thousand rupees is the most difficult part. Once you have it then it will encourage you to save more.

What is an Emergency Fund and why you must have one? – closing thoughts!

We hope by now you have understood the importance of an emergency fund in our life. As life is full of uncertainty we do not want our future to get trapped into debt and break us financially. Your first step towards building an emergency fund will give you peace of mind and some kind of certainty when you need the most.

Having an emergency fund makes your financial planning so much easier and gives you peace of mind.

Final Thoughts on Emergency fund

In my experience, having an emergency fund is crucial for financial stability. It’s like having a safety net to fall back on when unexpected expenses arise, such as car repairs or medical bills.

I started by setting a goal for how much I wanted to save, and then I made a plan to reach that goal. I made sure to keep my emergency fund separate from my regular savings account so that I wouldn’t be tempted to dip into it for non-emergencies.

To make it easier to save consistently, I set up automatic transfers from my checking account to my fund each month. Starting small and increasing my contributions over time helped me build up my emergency fund without feeling overwhelmed.

Over the years, my emergency fund has provided me with peace of mind, knowing that I have a financial cushion to rely on when I need it most. Building an emergency fund may take time and effort, but it’s worth it for the financial security and peace of mind it provides.

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FAQ on Emergency fund