Besides a savings account, one should also have money set aside for a financial emergency –  any emergency which is unplanned and unexpected.

A financial emergency differs from case to case. However an emergency is something that one needs to plan ahead for by saving because when it occurs it takes someone by surprise and should not create a financial dent.A financial emergency can be due to

  • A medical emergency
  • Job loss or extended leave
  • Death of a family member or close friend
  • Emergency home expenses

Emergency Fund – Definition and the Importance

An emergency fund is essentially the money that is set aside to cover any of the above mentioned life’s unexpected events. This money will enable one to live for a few months should anything unforeseen happens that leads to the need of some amount of money to cover the unfortunate event. It should be quickly and easily accessible on occurrence of such an event.

Thus the true importance of an emergency fund lies in the fact that it saves one in the event of an emergency.

Emergency Savings – how much is enough?

Emergency fund is the first step towards implementing a good financial plan as it helps to tide over an unexpected expense or to manage a family crisis. For example, if a working person quits or loses his/her job, an emergency fund should be ideally able to meet the expenses for up to six months.Many prefer to keep away 8-9 months’ expenses for contingencies. However, this leads to locking away a large sum in low-yield avenues.Thus, a preferable goal is to keep aside at least 6 months of living expenses in an emergency savings fund and keep it untouched unless one is using it for an emergency.

We at Dilzer consider emergency fund equal to 6 months one a family’s expenses if both husband and wife are working. If only one family member is working the emergency corpus should go up to 9-12 month of a family’s expenses.

A month’s expenses can include the following

  • All utility bills, all loans (home, car) , insurance, groceries and other essential expenditures likeschool fees, health care etc.
  • Basic entertainment items and incidentals that crop up during the month should be included as well.
  • Bills or other expenses that are payable once or a few times in a year, like yearly car maintenance, quarterly auto insurance etc.

Ways to Build an Emergency Fund

The most important thing is to get started and to remain consistent so that over time one can reach the emergency fund goal.Here are some tips for effectively building the emergency fund:

Break it down. One has to decide how much is needed inthe emergency fund and then decide on a figure as to how much to keep aside for the same each month. Then, simply determining how long it will take to reach the target based on the regular monthly contribution should do. Reduce Over expenditure. Reducing over expenditure such as over-ordering at restaurants, excessive watching of movies in mallsetc and using the money to build up emergency fund is a must.

Making it automatic. Scheduling regular payments from the main account to the emergency fund account, using ECS facility should help.

Celebrate milestones. Keeping a track of goals and marking special achievements by way of a small treat is a good way to reward and motivate oneself to keep going.

Credit Cards for your Emergency Savings Fund Amount?

Using credit cards or lines of credit to help one get out of an emergency, should be the very last option.

This is because when a person is paying for an emergency by credit card, one is paying much more for the emergency than is actually needed.   The credit card interest will add up over time and will make it much harder to pay off the debt in the future. As on date credit card rate of interest is between 24%-42% per annum compounded for each month of non payment. And the debt will add up if one lacks the discipline required to pay off the card in a reasonable time frame.

Thus having some money put aside in a fixed deposit or savings account helps because then a person does not end up paying more than one should.

The only time when using a credit card for an emergency makes sense when there is enough money in the savings account to pay for the emergency situation, but one has the opportunity to get cash back or points with the credit card.  And one should have the discipline to pay off the credit card bills regularly to reap the benefits of the card, too.

Finally, a credit card does come in handy when one faces a financial crisis, but the cushion that the plastic money provides lasts only for 15-30 days, till the bill comes in.

Is it possible one does not need an Emergency Fund ?

The importance of setting up an emergency fund cannot be exaggerated . Everybody should have one, though some may not have the need to put away the requisite amount in a fund if they have sufficient assets.

How to stop yourself from Spending Your Emergency Fund

Know clearly why the money is being saved:  One should be clear about why he/she is saving the money for, which in turn can be done by having a separate account allocated towards Emergency Fund, which one knows should be untouched.

Make the savings hard to access:It is better to move the account to which least access is required i.e., the emergency fund account to another bank.

Having spendable savings:Even if the savings are kept somewhere it is inaccessible, there still might come a time when one actually do need the money. That’s where the spendable savings comes into picture i.e., keeping apart some savings for spending.

GoodMoney Habits: Put some money aside

The best thing one can do, is to prepare for emergency and make it an habit to save and put some money aside for the same.One must develop the discipline to accumulate enough money for emergency fund so that it can help during unexpected setbacks and reduce dependence on borrowing money, most likely at high interest rates.A person should develop a systematic plan to build up an emergency fund over a period of time. Make sure you replenish the emergency fund withdrawals made within 1 month from the contingency.

Debalina Roy Chowdhury

Dilzer Consultants

 

Sources

https://www.debtroundup.com/the-true-importance-of-an-emergency-fund/

http://blog.conqueryourdebt.org/2016/02/15/what-is-a-financial-emergency/

http://profit.ndtv.com/news/your-money/article-how-to-save-for-an-emergency-fund-371280

http://www.moneycrashers.com/start-build-emergency-fund-savings/