How to build an Emergency Fund in 2021?
May 07,2021 Savings, Peer to Peer Lending
The ongoing Covid-19 pandemic has hit India's economy hard, triggering a credit crunch for many people. The mishap has made many families realize the importance of having an emergency fund. A contingency fund or an emergency fund is a specified amount set aside for unforeseen emergencies. These can be medical emergencies, short-term job loss, salary deduction or sudden travel due to family emergencies.
What is an Emergency Fund?
An emergency fund helps you and your family to financially face a medical emergency, unavoidable household repairs, sudden loss of job or salary cut or something that impacts the community at large such as social unrest or a pandemic like the current one.
Importance of an Emergency Fund
Life is full of unexpected situations good and bad. Hence, apart from other things, you need to be prepared for it financially. While you can plan for some foreseeable expenses, an emergency fund can help you manage all unplanned expenses efficiently. The current pandemic is an example of one such unplanned expense.
People with an emergency fund were in a much better position to manage lockdown than those who don't. During financially difficult times, an emergency fund can help you stay afloat without having to rely on credit cards or personal / instant loans. If you already have personal or home loans that you are paying off, then an emergency fund can help you avoid borrowing more.
How to set an Emergency Fund?
The first step is to estimate how much funds is required to meet any sort of emergency. Every individual / family has different financial needs. Hence, the amount will vary for all.
Before calculating the amount of the emergency fund, it is important to calculate the minimum amount one needs to get through the inevitable monthly expenses. This should include house rent or loan instalments, insurance premiums, utility bills, groceries, etc.
An emergency fund should be enough to fund the monthly expenses for up to 6 months, or up to a year if an individual fear a job loss or feel things are uncertain on the financial front.
How much Emergency Fund needed?
Every individual or family has different financial needs. Each individual or his family has a unique combination of lifestyle, no. of dependents, total income, and inevitable expenses. Hence, the amount / emergency fund required will be different for all. Before calculating the amount of the emergency fund you need, it is important to calculate the bare minimum amount you need to get through the inevitable monthly expenses. This should include house rent or loan instalments, insurance premiums, utility bills, groceries, etc. Ensure that you don't include unnecessary expenses that movies, travel, etc. in this amount. Once you know your every month expenditure, try to create a cash fund that can help you survive 3-6 months without any income. Given the current COVID or partial lockdown situation, most people will agree that six months of basic living expenses stored as an emergency fund is always a must to manage demands efficiently.
How to manage an Emergency Fund?
Just saving up some money is not enough. Just as you strategize to save for the goal, you need to have a plan for its arrangement and use.
There are three crucial aspects to look at when deploying an emergency fund: Security, Accessibility, and Liquidity.
Security: The money in this contingency fund is to help you through a difficult situation; hence, you can't utilize it anywhere where there is risk of capital loss in the short term. Equity / equity-based mutual funds or any other option with a fairly high risk should be avoided.
Accessibility: Generally, emergencies strike swiftly. If you do not have apt access to your emergency fund, it is meaningless. Ensure that the contingency funds are easily accessible so that you can take care of immediate expenses.
Liquidity: Liquidity refers to how speedily your investments can be converted to cash. Fix deposits, Government bonds, Provident Fund (PF), National Savings Certificate (NSC), etc. do not work as they are either irredeemable before maturity or have an upper limit on withdrawals.
Keeping these factors in mind, you can try the 20:20:60 method for deploying your emergency or contingency fund.
Cash: Keep 20% of the money in cash. Keeping too much cash in the house is not recommended from a security point of view. Additionally, over a period, unused cash loses its value due to inflation and soaring cost of living.
Bank Deposits: Another 20% could be held in your bank accounts securely. It takes away the probability of spending the money and the monies will earn a small interest of 4% on the savings bank account.
Investment: The remaining 60% of the fund can be invested either in short-term fix deposits or low risk mutual funds. Your investments in these debt instruments can be liquidated through the fund house or Demat account or bank's app or a physical request, and the funds will be deposited into your bank account within a day or two.