An emergency fund takes care of your financial emergencies and is must for financial security. Calculate your emergency fund amount and start accumulating it to make your life easier.
Financial emergencies do happen. They can happen to anyone and at anytime, infact, they happen when least expected. Financial emergency is a situation when we are left to face a sudden big expense which we have not expected. Such an emergency can ruin anyone’s financial planning or make life miserable if we have no remedy available.
The situation becomes even worse if our income has stopped or decreased. To see through such difficult times, we need to have an emergency fund. This is our rainy day fund which makes our life easier at the time of an emergency. These emergency savings help us meet those expenses and save us from falling prey to loans or credit card debts.
Recent outbreak of worldwide pandemic coronavirus by covid-19 virus is an example of financial emergency where people have been left locked to their homes. There is so much of employment loss and people are left to the mercy of the authorities, even to get food to stay alive, under lockdown. That has exposed how much number of people are unprepared to handle the financial emergencies even for few days of time.
If we have planned well and built an adequate emergency fund already to be prepared for any situation like this, we could have easily avoided situations of panic with no money in our bank accounts.
It is important that from now onwards we become serious about our finances to deal with situations of financial emergencies. Most of the people do not have their emergency funds and they are on paycheck to paycheck situation. Having an emergency fund at our disposal ensures that we handle the worse times with ease. That reduces a lot of stress out of our life.
What Is An Emergency Fund
An emergency fund is simply sum of money in your bank account which is readily available and you can use at the time of sudden emergency. The purpose of this fund is to create a safety net of cash. Emergency can be anything like we talked above without which it is difficult to carry on our day-to-day needs. It can be damage to your car and without repair you can not go to office, problems to your washing machine or refrigerators. Sometimes, people face the worst situation of loss of job and it is not easy to find a job soon enough.
Planned expenses are not covered under emergency fund. They can be like education related expenses like college fee, any vacation, marriage party, buying garments or household appliances like music system, televisions. It is important to differentiate between needs and wants.
Having an emergency fund ensures that we are able to handle the financial emergencies without the need for borrowing from banks or friends. This saves us of the embarrassments and high interest rates on the loans.
How Much Money Should You Have In Your Emergency Fund
Different financial planners may tell you different things about how much money you should have in emergency fund. Simple thumb rule states a minimum of three to six months to one year of your income as recommended emergency fund amount.
To be more precise, you can check your last credit card statements and list your regular expenses. You can use an emergency fund calculator to calculate how much amount you need to have in your emergency savings fund.
As a thumb rule, A fund to cover at least six months of expenses is how much emergency fund you should have. Three months time is very less if you face an unfortunate situation of loss of job.
Creating An Emergency Fund
You can start an emergency fund building process with a strong will, effort and time. You would have to maintain a discipline in your financial management. You have to a create household budget of your income and expenses to walk the path. You have to concentrate more on your needs and keep your wants behind for some time.
If you are already under a debt, you should also focus towards clearing that debt. In that case, your both tasks should be going on simultaneously. You can not afford another debt if you face another financial emergency in the meantime.
Creating an emergency fund needs small and regular steps towards saving money and cutting the expenses. Fix a goal and divide the target fund amount into equal installments depending upon the time period you would take to complete the goal. Start allocating money regularly and see you emergency fund building up.
You should make a habit to save some amount from your income regularly and build savings. Ideally, you should save at least 25% of your total income regularly. Fix an amount out of your regular income after spending on the needs and start saving in banks.
Keep putting that money in a separate bank account which you normally do not use for withdrawals. You can spend some money left after spending on needs and savings for your wants.
The purpose of building an emergency fund is not to make your life miserable but to bring a financial discipline and financial security.
Review Your Expenses
You should review your expenses and find the ones making a big hole in your pocket. Auditing of income and expenses is very important to achieve the goal of savings.
You will find so many ways of saving money like cancelling unnecessary subscriptions for some services you might not be using, your cable or dish tv channel packs which you are not interested in watching, disconnecting rarely used landline telephones if you have mobile phones, multiple online streaming sites like netflix, amazon prime and so on.
You should discontinue whatever you do not need or you can live without unless you complete your goal of accumulating emergency funds.
Sell The Unwanted Items
Every house has something lying idle which is of no use. It can be old mobile phones, computers, furniture. You can sell them offline or on online websites like ebay, olx and earn money. Put that money into your emergency fund and move towards your goal more fast.
Insurances are the instruments to take care of emergencies. In the event of any sudden expense, you can simply take the advantage of insurance covers. That can save your emergency fund from such expenses. Multiple insurances are available for different requirements. There is health insurance for illness, auto insurance for vehicular repairs, travel insurances to cover expenses related to travelling and term insurance or life insurance to cover the loss of life.
Where To Put Emergency Fund
Next question comes to your mind now ; where should I put my emergency fund?
Well, the answer is the best place to keep emergency fund is where it is easily and readily available at the time of need. Additionally, it yields good returns so that you can earn some income on it also. Keeping the whole amount in a bank account is not a wise thing to do. Savings bank account do not give interest rates more than 3 – 4% normally. If you put it in high return yielding vehicles, then the funds may not be readily available at the time need.
Thus, you can divide your funds into two types to fulfil the dual purpose of getting high returns as well as easy and quick availability :
Short Term Emergency Fund
Keep some part of your emergency fund in a regular savings account. The high interest rate savings account is the best savings account for emergency fund. Compare savings account interest rates from different banks and find the best one for you. The money in savings account should be available for withdrawal at any time. It will be yielding less interest rates but quick availability is more important than income on our holdings.
Long Term Emergency Fund
Major part of the emergency fund can be invested in debt instruments. The advantage of keeping money in these accounts is that they yield better returns with nil or little risk. Thus, they help your money grow when it is not needed. In case of an emergency, you can get your money in 24-48 hours. By that time, you can use the money you put in your savings account.
There are good options where you can put your long term emergency fund :
Liquid funds are debt mutual funds. A mutual fund is a common pool of money from a number of investors and managed by professional fund managers. Mutual funds have the potential to yield inflation beating returns on the investments.
Debt mutual funds are low risk category money market funds with almost nil risk. However, they yield very good returns. Most of the funds usually an earn you 7-8% annual return which is even better than some fixed deposits after tax deductions. There is no entry load. The funds can be redeemed anytime without any penalty or exit load. You get money in your account normally in one business day.
Liquid funds are the best place to invest money for 1 year or less. You can invest in liquid fund in systematically investment plan (sip) route by putting small amount regularly and systematically.
Certificate Of Deposits (CDs)
Certificate of deposits or CDs make another good vehicle to park your emergency fund. They offer a very good rate of interest on your holdings. However, the drawback of CDs is that everyone is not eligible to get a CD. Moreover, you need to put a certain minimum amount to get a certificate of deposit. Minimum time period to put your savings in a CD is three months by some institutions to one year. You can put money for upto 10 years period of time.
One year period is very long for an emergency fund to park. Hence some financial planners advise opening multiple certificate of deposits with different maturity date, thus building a CD ladder ; one for one year, second for 2 years and third for three years. The interest earned is kept by the holder and the money invested again if not needed. CD laddering ensures that liquidity remains available as at any time one CD shall be approaching its maturity.
High Yield Bank Accounts
Some institutions offer high yield bank accounts which offer higher interest rates than normal savings bank accounts. They are high interest rate accounts along with the added advantage of money being always available to you. You can inquire about the high yield accounts in the banks in your area and opt to put your emergency fund in a high yield bank account.
Having an emergency fund is an important part of your finances. These rainy day savings help us face the financial emergencies with ease. Every individual should have his/her emergency savings to avoid the unfortunate situation of falling into financial emergency.
If you have it, make sure you do not spend it for unnecessary things or luxury items. Whenever, you have to spend it for an emergency, it is imperative that you restore it as soon as possible. If you do not have it yet, then it is the time to be serious and start building it. Having an emergency fund gives you a sense of financial security and peace of mind in difficult times in life.
Do you have your emergency fund ready for you already or moving to starting an emergency fund building process?