Emergency fund 101: How to start and why it’s crucial for your finances?
Emergency fund is money stashed away to be used for unforeseen costs and expenses thus easing the financial stress arising during difficult times.
If you are invested in stock market, it is essential that you back your investment with an emergency fund. The volatility of the market can give you huge profits on one hand and on the other may not leave you with enough funds to meet your unexpected emergencies. Emergency fund helps us tackle such unexpected scenarios without having to avail a emergency loan.
What is an emergency fund?
Emergency fund is money stashed away to be used for unforeseen costs and expenses thus easing the financial stress arising during difficult times. Its main purpose is to create a safety blanket and reduce the need to avail high interest debt options. Assets used to maintain emergency funds should be cash or any other highly liquid asset.
Why is it important to maintain an emergency fund?
One should maintain an emergency fund for financial crisis like a job loss, medical emergency, mortgage payment, etc. An emergency fund also discourages the person to avail loans or other debt facility with high interest rates. It should be noted that the emergency fund should be spent only there is a disruption in inflow of income.
How much money should one save in an emergency fund?
Depending on the stability of the income and the number of source of income, one may decide upon the amount of money to be saved as emergency fund. As a thumb rule, one should save at least three to six months of salary. In case you are anticipating a short term large expense or if you rely on only one source of income, then emergency fund may be increased.
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How to build an emergency fund?
Firstly, determine the amount that you think should suffice to cater any emergency needs. You start by categorizing your regular expenses as necessary (house rent, insurance premiums, EMIs, bill payments etc.) and unnecessary (movies, vacations, dining out, buying expenses gifts etc.) In case you know of any short term large expense to be spent in the near future like purchasing a new car, you can take the same into account while creating an emergency fund. Then instead of withdrawing a large lump sum to meet the expense, it is advisable to set aside some money every month towards the emergency fund. If planned wisely, saving a small percentage of your after-tax income every month can create a surplus emergency fund.
Where to invest the emergency fund?
Since emergency funds are required in times of urgent need, it is advisable to invest in liquid avenues like fixed deposits with higher interests, liquid funds or recurring deposits. Some other ways to store money for emergency fund are high interest earning saving accounts, money market accounts and no-penalty certificates of deposit.
How to maintain the emergency fund?
You could follow certain ways mentioned below to increase or maintain a good emergency fund.
- Add all the financial bonuses received or tax refunds to the fund whenever possible.
- If there is an increase in the expenses then you should revise your savings goals and recalculate the emergency fund amount and save accordingly.
- You should dip into the emergency fund only when genuinely needed.
Emergency fund help tackle little disasters in a more managed manner. Emergency fund is money kept aside to cover unforeseen and unexpected expenses. They can help in avoiding a high interest rate loan. You must take care not to utilise the emergency fund in unnecessary expenses. You should also maintain and regularly invest in the emergency fund. This you can do by saving the tax refunds and bonuses and keeping them aside as emergency funds. The instrument used for emergency fund should be highly liquid and has no charge for withdrawing money before its maturity period. Whether you need a personal loan, home loan, loan against property, or a business loan, IIFL Finance has you covered. With competitive personal loan interest rates, flexible repayment options, and a seamless online application process, applying for a loan has never been easier.
Frequently Asked Questions
1. How much money should I have as emergency fund?
The amount varies according to your living expenses, but the general rule of thumb is to eventually save three to six months of living expenses.
2. How can I create an emergency fund if I am a salaried employee?
You can set aside a small percentage of your after-tax income as an emergency fund.
3. What is an emergency fund used for?
An emergency is an unexpected bill that you can’t pay—not money to go to a movie or for some other nonessential expense.
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