Uncertainties are a part and parcel of life. Some days things go smoothly as per your plan, while some days bring unexpected challenges. And these challenges come with financial setbacks.
So, what’s the solution?
An emergency fund.
Now, before we dive into explaining the 5 steps to build a solid emergency fund, let us first understand what exactly an emergency fund is and how it acts as a cash cushion against financial uncertainties.
In simple terms, just as the name states, it is a fund created for getting financial help during emergencies or unforeseen events. But it is important to note that it is not the same as a savings account or insurance. This is mainly because a savings account is used to set aside money for fulfilling your goals. And even though the purpose of insurance is to help you during certain financial emergencies, they do not cover every type of unexpected financial need.
Emergencies can occur in any form, so despite having insurance coverage, it is important to maintain an emergency fund to protect yourself and your loved ones from any unpredictable financial crisis.
As per a case study conducted by YouGov, a British international Internet-based market research in 2021, only 2 in 5 urban Indians consider saving for emergencies as their top priority. This major financial planning mistake often causes difficulty in arranging funds during an emergency or forces you to withdraw money from your investments or savings.
So, secure your portfolio by understanding the 5 steps to build an emergency fund.
1. Setting up a separate account for your emergency fund
As we previously mentioned, an emergency fund is different from a savings account. So, you need to create a separate account that only caters to your emergency needs. Moreover, it makes it easier for you to track your fund’s progress and helps you to plan more efficiently based on the results. Liquid mutual funds or any other debt funds where you can get instant withdrawal facility are a few options you may consider to park your money for emergencies.
In short, separating your emergency fund from your primary accounts will simplify your financial management and make things easier during tough times.
2. Calculate how much money you need to keep in an emergency fund
The standard amount that experts usually suggest keeping in an emergency fund is around six months of your living expenses. This includes your rent, utilities, food, debt, subscriptions, and any other recurring expenses. However, if your job security is very low, then you may consider saving up to 8 to 10 months of your living expenses in an emergency fund. Based on this parameter, you may calculate and decide what target amount you want to set for your emergency fund.
3. Automate your savings into the emergency fund
The best way to ensure consistent contribution to your emergency fund is to set up automatic transfers. You can even opt for the sweep-in Fixed Deposit facility offered by banks. This facility links your savings account to your FD and allows you to transfer excess or idle funds from your bank account to your FD account so you can earn higher returns.
This way a portion of your income will be regularly directed to your emergency fund making it a convenient and hassle-free way of maintaining adequate balance in your fund. Additionally, it regulates a disciplined system wherein you won’t forget to initiate the transfers and helps you prioritize your financial well-being.
4. Create a budget and identify areas where you can save money to contribute to your emergency fund
A lot of times you may find it difficult to meet the monthly target you have set for your emergency fund due to the increasing prices of your daily household utilities, lack of tax-saving plans, lifestyle adjustments, etc. So, it is important to create a budget and analyze areas where you can avoid unnecessary expenses and save more to contribute towards your fund. This will not only create a strong emergency fund but will also help you to inculcate the habit of saving.
5. Staying disciplined and avoiding dipping into your emergency fund for non-emergency expenses
It is crucial to differentiate between your emergency and non-emergency expenses. If you start using your emergency fund for any major expenses, you won’t have sufficient funds left during any actual financial urgency. The bottom line is to stay disciplined with your fund and avoid unnecessarily withdrawing money from it.
Conclusion
In conclusion, an emergency fund is a great way to begin financially preparing yourself for any situation. By following the above-mentioned 5 steps and staying committed to your financial goals, you can build a strong foundation for your financial growth.
