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Having an emergency fund is important as it can help you in the future. Most people know what an emergency fund is, but there might be some who don’t know it. If you don’t know what an emergency fund is then we are here to enlighten you. An emergency fund is a type of fund that is designed to pull you out and cushion you against life’s unexpected moments.
What is an Emergency Fund?
An emergency fund is a pool of liquid money set aside for unforeseen expenses. It is available for use anytime and anywhere. Having an emergency fund lets you save money for the future. You can save the money and use it at a later date. The amount you invest does not change and there are no gimmicks like withdrawal fees or exit load charges involved.
Why Do You Need an Emergency Fund?
Here are a few reasons why you should set aside a certain amount for your emergency fund per month.
1. To Prepare for Unexpected Events
You never know what life will throw at you the next day, hence it is important that you have an emergency fund. It will bring a level of security in your life. Emergencies can include medical expenses, paying for your child’s higher education more than expected, etc. With an emergency fund, you will be able to save up a lot and bear all these expenses without any worries.
2. To Learn to Save Money
When you get into the habit of investing a certain amount of money whenever you have excess cash, you actually adopt sound financial behaviour. Having an emergency fund will teach you how to be disciplined with money and you will learn to avoid overspending whenever you feel like.
3. For Instant Funds
Emergency funds are immediately available for use – be it short-term or long-term. Cash will be available to you instantly and you won’t have to worry about withdrawal or exit load charges. To make matters better, emergency fund accounts are directly tied to your debit card, RD, and fixed deposit schemes.
4. For Repair-related Work
Let’s say a household appliance is out of warranty and it suddenly breaks down. If it is of extreme importance to you and you simply cannot do without it then you can use your emergency funds to get it repaired. An emergency fund can provide you with money whenever you need it.
How Can You Build an Emergency Fund?
You can build an emergency fund in India in the following ways.
1. Start Tracking Your Budget
If you don’t know what you’re spending your money on, you won’t be able to build an emergency fund. Find out where most of your money goes and whether it’s worth it. If it’s not, cut down the unnecessary expenses and start being more disciplined with regards to the money you spend.
2. Start Small But Be Consistent
You don’t need to set aside Rs 10,000 every month to build an emergency fund. You can start small to build up a fortune. You can even set aside Rs 2,000 or less for your emergency fund. The trick to building an emergency fund that works is to invest a small amount but regularly. This means that you should not skip saving even for a month.
3. Make Sure It’s Liquid
Make sure you put your money in a place where it’s easily accessible. You ideally want to make your fund as liquid as possible. You can invest in fixed deposits or recurring deposits of your savings bank. Make sure there are no lock-in periods if you plan on investing in any specific schemes. When you invest money in an emergency fund, make sure that the money will be easily available for you whenever you need it.
4. Opt for Automatic Transfers
You can instruct your bank to automatically transfer any excess money into a fixed deposit every month. This way, you will earn a higher rate of interest as compared to saving money in an existing savings bank account. Also, make sure you dedicate to saving at least 25% of your money and putting it into your current savings bank account.
5. Cut Down on Unnecessary Expenses
There’s no way you will have a good emergency fund if all you do is just spend whatever you earn. You have to get into the habit of saving money. Spend on important things and avoid spending in excess.
6. Make Sure the Amount Saved is Equal to Your Six-months’ Expenses
Your emergency fund amount should equal up to six months’ of your regular monthly income in total. This is to ensure you’re covered for cases when you are unemployed or don’t have any supplemental income.
Where Should You Invest in India for an Emergency Fund?
Your first option when it comes to going for your emergency fund investment options should be your savings bank account. You should put at least 25% of your money into your savings bank account. The upper withdrawal limit for these accounts is usually Rs 40,000 a day and most of these have a direct chequebook and debit card linked to them. Besides this, liquid mutual funds are another option where you can earn decent returns up to 8.52%. There are many schemes available like ultra short-term funds where the fund company lets you redeem the money directly without having to wait a day to transfer to the bank and withdraw. Besides that, you also have the option to opt for sweep-in accounts where some amount of money gets transferred automatically to your FD at the end of the month when recorded to be in excess.
Short-term debt funds are also another option where you can get higher returns. The important thing to note here is to consider your financial needs for the future when you’re investing. Your emergency fund corpus will be much higher.
How Much Can You Save in an Emergency Fund?
When you are planning to save money for an emergency, try to save up at least 3 to 6 months’ of your monthly income for it. For example, if you earn Rs 50,000 a month, your emergency fund should be worth at least six months’ of your earning which is Rs 3 lacs in this case.
You can further categorize the money you save in your emergency fund into long-term and short-term funds below.
Long-term emergency funding options can help you in the long run as mentioned. Some long-term emergency mutual fund options let you earn higher interest rates when you stay invested for a longer period of time.
By investing in short-term emergency funds, you will have money whenever you need. Good examples of short-term funds include FDs, RDs, and any short-term debt funds. Whenever you plan to invest in short term funds, you should check if the money can be withdrawn easily or not. Your savings bank account is the best example of keeping a portion of your emergency fund parked in it when it comes to meeting your short-term financial emergencies.
Here are some frequently asked questions and their answers with regards to emergency savings funds.
1. Is an Emergency Fund Similar to Savings?
Emergency funds are not the same as your regular savings. In a savings fund, you invest the amount for longer periods of time. The goal of savings funds is to generate wealth and higher interest rates without redeeming the funds throughout the duration of the investment. In the case of emergency funds, your goal is to make your funds instantly accessible rather than focus on how much money you make by getting the interest. This is the key differentiator between the two.
2. How and When to Redeem Money From an Emergency Fund?
If you’re investing in any debt mutual funds or similar schemes, check with the fund house to see if they allow instant redemptions. Most of them do and investors get to withdraw up to 90% of the cash they invest in these schemes. You should ideally redeem your emergency fund money either when the time period for staying invested in is up so that you can reinvest the proceeds made or when you face a time of financial crisis or emergencies like medical expenses.
Most people don’t take the effort to save money or set up an emergency fund. But if you have an emergency fund, it will help you in the future. At least, you’ll be stress-free and not worry about where you get your money from when a crisis hits you and that’s the point of it.