The recent pandemic and economic conditions after that have highlighted the importance of savings or emergency funds. But still, a large portion of the Indian population, around 75% do not maintain an emergency fund. It is important to understand that it can prove to be useful to get past unpredictable times. This article will explain more about setting up and maintaining an emergency fund.
Table of Contents
- What is an Emergency Fund?
- What is the Need for an Emergency Fund?
- How to Start an Emergency Fund?
- Where Should I Keep an Emergency Fund?
What is an Emergency Fund?
An emergency fund or a rainy-day fund is a kind of savings mostly done in cash, and it is mainly put aside to cover all types of unplanned expenses or financial emergencies. The emergency fund should be set up in a way so that it is easily accessible whenever its need arises.
Common monthly expenses or other kinds of unnecessary spending should not be done with emergency funds. If it becomes necessary to use the emergency fund, then it should be replenished as soon as possible.
It is mostly suggested that an emergency fund should be able to cover at least 3 to 6 months of expenses when needed. So, it is important to use it wisely by assessing the situation and its impact.
What is the Need for an Emergency Fund?
An emergency fund can be used during sudden monetary needs, and it helps people to avoid using their regular savings or taking loans if they get stuck in a financial crisis. It also provides financial stability and protects savings set for other key events like retirement.
Saving a small amount of money regularly provides peace of mind during emergency situations like health problems or job loss, and you can focus on solving the problem at hand.
How to start an Emergency Fund?
There are several ways for setting up an emergency fund, and we have discussed the major ones below:
Set a Goal
You should decide how much money you want in the emergency fund. The amount of money you can put in rainy day fund depends on your income and expenses. So, it becomes important to first calculate the expenses and then plan the savings accordingly.
Initially, creating a savings plan can seem like a far-fetched idea, but starting with a small and fixed amount can slowly help build an emergency fund. Once you achieve your initial goals, then increase your savings to create a good enough emergency fund.
Plan your Savings
If you are living paycheck to paycheck, then it could get difficult to maintain an emergency fund. But better planning, limiting unnecessary expenses, keeping track of expenses, and putting a specific amount of cash aside each day, week, or payday can help grow your savings. Also, if you are only using cash for emergencies, then putting in small change can also help. If you come across big amounts like bonus or investment returns, then a portion should be transferred to emergency fund.
Automate your Savings
Manually creating an emergency fund is also possible, but you can lose track or forget, so automatic transfers to a separate account can help in such situation.
By automating your savings, it becomes easy to set aside an emergency fund. A separate savings account that only holds your emergency fund should be set up with automatic and regular transfer of funds from your primary account.
Choose Ideal Saving Methods
Regularly saving money and quick access to it are the primary goals of an emergency fund, instead of higher returns. So, while considering creating an emergency fund, you can choose between a savings account, a Fixed Deposit (FD), or Liquid Mutual Funds.
All these methods have their own pros and cons that we will discuss in the section below. Constantly try to increase your emergency fund contribution over time and reassess your savings regularly to keep a check on the amount collected.
Where Should I keep an Emergency Fund?
There are many options available when it comes to saving for an emergency fund. A savings account, fixed deposit, or mutual funds are usually the most preferred choice for building emergency funds.
Savings Account
Always keep a separate savings account where you can transfer rainy day funds from your salary account. Different banks offer savings accounts with varied interest rates. Choose a savings account with higher interest rates so that it helps grow your emergency funds over time.
Fixed Deposit
A short-term fixed deposit can also be a safe emergency fund, as it offers guaranteed returns, but withdrawal before FD maturation can result in penalties and loss of money. It is important to get an FD against which you can take a loan so that you can get easy access to cash without breaking the FD or paying any fines.
Mutual Funds
An emergency savings fund can also be built with mutual funds that have high liquidity and low risk. Also, some mutual funds offer higher interest rates than savings accounts, and this helps increase your emergency fund over time.
Mostly, liquid mutual funds and overnight funds are considered for emergency funds. Both these mutual funds offer quick withdrawal of funds, which are often processed within 24 hours. For someone who can wait for a day or two, they can consider ultra-short-term debt funds because they provide slightly higher returns than liquid funds. Another option that you can consider as an emergency fund is starting a Systematic Investment Plan (SIP).
A key point to remember here is mutual funds and SIPs are subject to market risks. So, proper research or taking help from professional financial advisors is required before choosing these options.
Key Takeaways
Recently, there have been many such situations that have led to financial strain for almost every working individual. Such uncertain times call for having an emergency fund that can provide a kind of safety net in challenging financial circumstances. A rainy-day fund keeps you at peace while handling sudden expenses that could have affected your savings.
There are different options available based on an individual’s goal, risk appetite, and liquidity. A high interest rate saving account, short-term FD, or mutual funds are some the options that can be chosen for setting up an emergency fund.
Frequently Asked Questions On How to Build an Emergency Fund in India
1. Define an emergency fund?
An emergency fund is a kind of savings that is set aside separately and mostly kept in cash or in highly liquid funds. It is done to get through any kind of unexpected expenses that could cause financial strain.
2. How can I build an emergency fund instantly?
An emergency fund cannot be built instantly. It needs to be Built systematically using automated transfers and aggressive cutting of discretionary expenses. But in case of an emergency, you can always go for a loan or use credit cards.
3. Where to keep an emergency fund?
Some of the best options to keep an emergency fund include savings accounts with higher interest rates, short-term fixed deposits, liquid mutual funds, etc. Safety, easy access to the funds, and stability over higher funds are some things to be kept in mind while setting up an emergency fund.
4. Is a 3-month emergency fund good?
A 3-month emergency fund is a good start, but in some situations, like a job loss or health crisis, it might not be enough to get you through that situation. That is why it is usually recommended that an emergency fund lasts at least 6 months to easily handle any kind of crisis.
5. Can I diversify my emergency fund?
Yes, you can diversify your emergency fund, but it should only be done once you have collected a substantial amount to meet your needs. Highly liquid and low-risk options can be chosen to diversify an emergency fund.
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