The Elusive Emergency fund – Why is it needed
The Vital Role of an Emergency Fund
An emergency fund is a financial lifeline set aside to cope with life's unforeseen events. It provides the means to navigate unexpected challenges that may require immediate financial support. The paramount importance of an emergency fund becomes apparent when it acts as a savior in times of crisis.
Covering Essential Expenses
Beyond just having a savings account, establishing an emergency fund is imperative. It ensures preparedness for unexpected and unplanned circumstances. When calculating the size of your emergency fund, consider essential expenses, which include:
Housing Expenses: Your emergency fund should encompass costs like rent or mortgage payments, property taxes, insurance, and utility bills. It's wise to allocate a portion for unexpected home repairs.
Food: Monthly food expenses should also be part of your emergency fund planning. Reducing dining out, taking advantage of sales, and utilizing grocery coupons can help you save on food expenses.
Insurance: Account for monthly medical insurance expenses and any additional costs related to disability or life insurance policies you may hold.
Transportation: Emergency savings should cover crucial transportation-related costs, including car loans, auto insurance, regular maintenance, annual servicing, fuel, and unexpected repairs.
Personal Expenses: Don't forget to include costs for household supplies, clothing, haircuts, and toiletries when determining your emergency fund's size.
Building Your Emergency Fund
Once you've identified the expenses to be covered by your emergency fund, the next step is creating a savings plan. Here's how to get started and gradually build up your fund:
Allocate windfalls: Save any substantial windfalls, such as tax refunds, holiday bonuses, or monetary gifts.
Regular contributions: Commit to setting aside a percentage of your monthly salary for your emergency fund
Automated transfers: Establish automatic transfers to move your savings into a dedicated account.
Consider SIP: Consider Systematic Investment Plans (SIP) in liquid or arbitrage funds to address annual expenses like school fees, insurance premiums, or taxes.
Monitor your progress: Regularly track your progress toward your emergency fund goal using a tracking tool you can access conveniently.
Address debts: Recognize that carrying debt can be a hindrance to savings. Prioritize paying off debts, as it will free up more money for your emergency fund.
Determining the Appropriate Size of Your Emergency Fund
Your emergency fund serves as the first line of defense in a robust financial plan, helping you navigate unexpected expenses and family crises. For instance, if you lose your job, your emergency fund should ideally cover up to six months' worth of expenses. While some prefer saving for contingencies equivalent to 8-9 months of expenses, this might involve tying up a substantial amount in low-yield investments. Thus, a reasonable goal is to set aside at least six months' worth of living expenses in your emergency savings fund, preserving it for genuine emergencies.
A Note of Caution
An emergency fund should never be used for anything other than genuine crisis situations. Avoid tapping into it for discretionary spending, and when you do use it, promptly replenish the fund. It's vital to maintain the fund in proportion to your evolving expense patterns.
Author: Debalina Roy Chowdhury, Dilzer Consultants