An emergency fund is essentially the money that is set aside to cover life’s unexpected events. This money will enable one to live for a few months should anything unforeseen happen, that leads to the need of some 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.
What Expenses should be included in an Emergency Fund
Besides a savings account, one should also have money set aside for a financial emergency . Establishing an emergency savings fund now helps later on the occurrence of an unexpected and unplanned event.
Here are some important expenses to consider when determining the amount to save with regard to emergency fund.
Housing expenses: The emergency fund should include savings for covering housing expenses such as rent or mortgage, property taxes, insurance, utilities etc. It is a good idea to include some savings aside for emergency home repairs.
Food: The monthly food expenses should be included in the emergency fund savings. Saving money on food by way of reducing the food expenses and adding those savings to emergency fund is a good thing to do. This can be done by curtailing excessive dining out, buying groceries when sale is around, using coupons while booking groceries on mobile application etc.
Insurance: Factoring in the monthly cost for medical insurance is a must.One should also factor in the cost of any disability or life insurance policies one may have.
Transportation: Emergency savings should cover necessary transport related costs like car loan, auto insurance, basic maintenance, annual maintenance ,fuel and emergency repairs.
Personal expenses: Costs related to household supplies, haircuts, clothing items and toiletries should be included when figuring out how much to save for an emergency fund.
Building the Emergency Fund
Once one is aware of the type of expenses the emergency fund should cover, the next step is to set up a savings plan towards this emergency goal. An easy way to get started and then build up this fund is:
To put any big payments, such as a tax refund,holiday bonus, monetary gifts etc away as savings.
Adding a percentage of every month’s salary to this savings should be a prudent thing to do, too.
Moving these savings into a designated savings account by way of establishing automatic transfers.
Initiating an SIP in a liquid or arbitrage fund to take care of annual school fees or insurance payments or tax payments is also followed.
Once a person makes the monthly savings the amount can be accessible whenever needed.
6 Steps To Build Up the Emergency Fund
Set a target number that feels possible:Goal-setting research confirms and proves that people are more successful when they set moderately challenging and reasonably attainable goals.Emergency savings goal should be approached like any other long-term goal and achieved.
Savings as a non-negotiable expense :Savings must be made a disciplined habit.A person must be proactive in directing savings into the budget just in the same wayhe/she would approach a utility or credit card bill and clear such payments.
Being real about needs :Identifying all of the essential expenses and doing away with other non essential expenses is a must.
Track the goal every week :Tracking progress daily or weekly towards emergency fund goal using a tool one can reference anytime and anywhere should be made a habit. One needs to track savings just the way one tracks expenses on a regular basis.
Don’t discount the cost of risk. Carrying debt is a common reason people postpone saving. There is a cost to the risk of not having savings. As a result, having emergency savings of at least six months of the salary should be a priority. In the process, by becoming more proactive in debt payoff strategy and paying off debts quickly one can devote more money towards emergency fund.
How Much Emergency Savings Does One Need/Figuring the Size of the Emergency Fund
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 be 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.
A word of caution
Emergency fund should never be used for anything other than a real crisis situation. For example there is an urge to buy a new attractive item, the money for emergency should be untouched. Moreover, when the emergency fund is used, it should be replenished at the earliest possible time and should always be maintained in proportion to the change in the expense patterns.