How much to Save for an Emergency Fund?

Tue, 26 Nov 2024

4 mins

Key takeaways:
 

• An emergency fund is a reserve of cash set aside in accessible accounts to cover unexpected expenses like medical emergencies or job loss.


• Aim to save 3-6 months' worth of monthly expenses; for example, if monthly expenses are Rs. 60,000, set aside Rs. 1.2 to 2.4 Lakhs.


• Start small with achievable goals, automate savings, reduce non-essential expenses, and stop over-saving once you've reached your goal.


• Opt for liquid investments, like liquid mutual funds or short-term fixed deposits, to keep your fund safe and accessible.

• What is an emergency fund?

  
  An emergency fund is a reserve of money specifically set aside to handle unforeseen expenses, such as medical bills, car repairs, or temporary loss of income. It’s best stored in liquid financial instruments, so you can quickly access it when needed.

• How to calculate your emergency fund?

  
  To determine the size of your emergency fund, start with your monthly expenses. If you spend Rs. 60,000 monthly, your emergency fund should be between Rs. 1.2 Lakhs and Rs. 2.4 Lakhs. This calculation uses the 3-6 months rule, meaning you should save at least three to six times your monthly expenses.

• Why is emergency fund important?

  
  It may be something like planning for some unseen events or emergency. If we take the example of current situation, there is huge percentage of people lost their jobs and are currently facing a lot of issues to fund their basic necessities. No one knows from where and when any sudden monetary requirement occurs.  It may be in different forms like hospitalization expenses, death, job loss or any natural calamities. 
  
  If there is one thing the ongoing pandemic has taught us, it is that an emergency can strike at any time and you can’t do anything about it other than being prepared.  While an emergency such as a natural disaster like earthquakes, floods, a health condition that keeps you off from work, an economic downturn causing businesses shut-down, job losses or salary cuts, might not be under your control but ensuring you have enough funds to steer through is under your control.
  
  How do you go about your life and meet your essential expenses in times like these? The answer lies in building an emergency fund that could help you sail through.
  
  Now the question arises, what are the ways one should build an emergency corpus without disrupting normal living expenses? The game of saving is mostly psychological and you can win it. Even if you’re starting from zero, regularly setting money aside even in small amounts will eventually get you to your goal. It just takes time and a little discipline. 

• Steps to Build Emergency Fund

  
  1. Set several smaller savings goals, rather than one large one
  Set yourself up for success from the start. Rather than shooting for three months’ worth of expenses right away, shoot for one month, or two weeks. Whatever it takes to make your first goal seem doable. Reaching that first goal can give you the motivation to keep going. Set your second goal higher — and the third even higher. By then, saving will have become a habit, and the positive motivation you’re building by reaching the smaller goals will help propel you toward larger ones.
  
  2. Start with small, regular contributions
  Set your initial contribution level at a relatively small amount. That will ensure you don’t stress your cash flow, making it too easy for you to rationalize abandoning your savings routine. Choose that amount whether it’s Rs. 500 or Rs. 5K and commit to saving it at regular intervals: per month, per week, or per paycheck. The key is that it needs to become a habit, not a recurring struggle.
  
  3. Automate your savings
  Out of sight, out of mind: the easiest way to save money is never to touch it in the first place. Set up a separate account just for your emergency fund and have your chosen contribution amount deposited automatically by your bank.
  
  4. Trim the expenses
  Once saving has become automatic, don’t go into a false sense of financial security and let spending creep up again. Reigning in on the non-essential expenses will allow you to get to your saving goals quicker, and maybe even increase the monthly allocation. You don’t have to go sudden, but just prioritize your expenses. Instead of eating out on a weekly basis, cut it down to one or two outings a month, watch movies at home, limit online shopping, etc.
  
  5. Don’t over-save
  Don’t devote too much of your savings to your emergency fund. By definition, an emergency fund is cash you can access quickly. That means you are most likely storing it in a low-yield vehicle like a savings account or Liquid MF that is earning an extremely low rate of interest. For that reason alone, you should stop contributing to that account once you’ve reached your ultimate goal. Start investing in diversified investment avenue where money starts earning on its own and time will enable it to bear the most fruit.
  
  The objective of building a contingency fund is to be able to fund an emergency. Therefore, for a contingency reserve to meet its purpose, it should be liquid. Even so, the best place to keep your emergency funds is in a savings or a liquid fund, not under your bed or in your cupboard. The idea here is simple. You are saving for emergencies and so the funds must be safe at all costs. The sunny side to this is that your contingency fund would also earn some return.

• Where to Invest Your Emergency Fund?

  Your emergency fund needs to be accessible yet safe. Consider placing it in:
   

  • Liquid Mutual Funds: These funds offer easy access and typically yield slightly better returns than a standard savings account.
  
  
  • Short-Term Fixed Deposits (FDs): Short-term FDs can provide a bit more stability and accessibility when compared to long-term investments.
   
  An emergency fund is like your financial safety net, providing essential security in challenging times. Prioritize building and maintaining it, so you’re prepared for any curveball life throws at you.
  
  “An emergency fund is like your parachute that saves you from a freefall in the event of a financial crisis. So, always give it the importance it deserves.”    

• To bring it to a close

  Building an emergency fund isn’t just a financial exercise—it’s a step toward peace of mind. By setting aside 3-6 months’ worth of essential expenses, automating your savings, and choosing liquid, safe investments like liquid mutual funds or short-term fixed deposits, you can create a financial cushion for life’s uncertainties.
  
  Secure your future by making your emergency fund a priority today. Because when life throws a curveball, you’ll be ready to catch it.