5 tips for building an emergency fund

The need for an emergency fund has never been this apparent. Unfortunately, most of us never really feel the need for it.

But just a few months back when the Yes Bank issue unfolded a friend of mine contacted me (this was before the RBI had guaranteed their pay). I had introduced the concept of an emergency fund to him a while back.

He was so glad he had followed through on the advice. And although he was worried about his future employment but providing for his family and his upcoming EMI bills wasn’t an issue.

So how much do you need to save?

Don’t go by what others suggest. Every family is different in terms of their sources of income and needs. Some are double income families, some have home loans etc. Eventually, you have to work hard and decide on a number that works best for your situation.

A good thumb rule is to save around 6-9 months of living expenses. These include your basic expenses like your monthly grocery bills, EMI, dining out and entertainments costs, child’s education, etc. The idea is to have enough money tied up to manage your expenses if you suddenly find yourself without any source of income.

Saving several months of living expenses can be a daunting task. Especially when every rupee you earn is accounted for. But following these simple steps can help you get started on building a reserve of cash along with greater financial security and peace of mind.

1. Start small. Break it down

Saving serval months’ worth of living expense can be intimidating. The key is to not focus on the entire amount. Look at it as a combination of smaller amounts that coalesce to form a whole. This will enable you to start somewhere. Even with smaller amounts. But if you are consistent you’d be surprised how quickly saving small amounts can add up.

2. Cut down on your expenses

Chart out your expenses and income. Identify your critical expenses and create a plan to set aside a certain amount each month. If required, follow a stringent budget for some time. It can help curtail some overspending habits you might not even be aware of. A survey revealed that most people end up overspending on food and entertainment. So that can be a great starting point. Continue to save until you have added enough to your fund. 

Make sure you review your budget and make necessary changes as you go along. You can accomplish this by using any of the effective online tools available these days.

3. Delay large expenses

An emergency fund takes precedence over everything. Even an annual holiday. On a normal basis, consider postponing your annual holiday and opt for a staycation instead.

But these times are different. Chances are you won’t be able to travel this year owing to the lockdown. Which presents you with a great opportunity to transfer those earmarked funds to your emergency fund.

4. Ensure that your emergency fund is accessible

Accessibility to the fund is a crucial feature as an emergency can strike at any time. The key is to invest the proceeds in a liquid, accessible, zero-risk investment instrument. Much like a fixed deposit or even a bond mutual fund that can offer a great post-tax benefit.

Seeing large sums of money generate minimal returns can be bothersome for some. But keep in mind that the emergency fund will not generate high returns. Its sole purpose is to be accessible at all times in its entirety.

Consider maintaining a separate account as large sums of accessible money is very tempting and susceptible to use.

5. Don’t allow your loans to interfere with your fund

An emergency fund is not related to anything. Your savings, your debt, your short-term financial goals. Nothing. It is just money kept aside for difficult times. And is the key to successful financial planning. 

But as challenging as keeping aside a large amount of savings along with making interest and debt repayments can be it is essential. Sure, if you have a high-interest carrying debt, re-pay that first. But if it isn’t, aim for working towards both goals simultaneously, re-paying your loans and saving for the emergency fund.

An emergency by definition doesn’t announce itself. It comes out of nowhere and usually at the worst of times causing a lot of emotional stress. The best way to deal with it is by preparing for it. And a well-funded emergency fund enables that. As it helps you sail through the worst of crisis and keeps financial stress at bay.