An emergency fund is a crucial part of your personal finance portfolio for it offers financial freedom and peace of mind. This corpus is specifically meant for contingencies like medical bills, job loss, vehicle repair, and can reduce your reliance on credit products like loans or credit cards. Having an emergency fund can protect your financial stability and empower you to make decisions without being clouded by financial stress. Building an emergency fund is as important as using it wisely. Let’s understand the various aspects of building your fund and times when you should dip into it.
Size of the Emergency Fund
The recommended size of your emergency fund should ideally be at least six times your monthly income. However, the size can vary based on your family’s needs. For example, a family member suffers from a health issue that requires constant medical attention. This should be factored in when deciding the size of your emergency fund. Also, your family’s need can change over time so the fund size must be reviewed from time to time.
Liquidity is key when it comes to an emergency fund. So, choose instruments that are easily accessible and have minimal or no penalty for withdrawal. Some options you can choose from are savings bank accounts, fixed deposits (FDs), sweep-in FDs, recurring deposits, and liquid funds. Automating a portion of your income to be redirected to your emergency fund each month can ensure that the fund keeps growing. Use any windfalls or bonuses to boost the fund.
When to Use Your Emergency Fund
Not every significant cost justifies using your emergency fund. It is crucial to distinguish between a true emergency and an unexpected expense. Here are a few situations where your emergency fund can come in handy:
- Income stops or decreases
A job loss or drop in income can be mentally and financially stressful to endure. Your emergency fund can help you take care of essential expenses like food, rent, loan EMIs, utilities, insurance premiums and more till you find another job. It can save you from taking on additional credit or having to borrow from family or friends.
- Necessary expenses
Unexpected yet essential expenses like urgent home repairs or vehicle repairs can be funded by your emergency corpus. However, try to take care of such expenses using your regular savings.
- Family emergencies
Unfortunate events such as a family member’s passing can be a difficult time. It may be accompanied by expenses like travel, funeral arrangements, or providing temporary support to family members. An emergency fund ensures you have the necessary financial resources for such times and allows you to focus on being with your family instead of stressing over money.
- Medical Emergencies
Medical emergencies can strike at any time and being unprepared for them can significantly strain your finances. Medical treatment and hospitalisation costs nowadays can be substantial and deplete your savings. An emergency fund can help cover such costs fully or partly thus reducing or eliminating the strain on your finances. Besides having an emergency fund, it is crucial to have adequate medical insurance that covers you and your loved ones.
Rebuilding Your Emergency Fund
If you have dipped into your emergency fund, make sure you replenish it to be prepared for future uncertainties. Here are the steps you can follow to rebuild it.
- Find out how much of your emergency fund you have used. This will give you the amount you have to replenish. Adjust the amount based on your family’s needs.
- Tweak your budget to prioritise setting aside money to rebuild the fund. Cut down on non-essential expenses and channel that money into your savings.
- If saving is challenging, set up automatic transfers to ensure consistent savings. Automating a portion of your income will ensure steady progress.
- Use windfalls or any surplus amounts to expedite replenishing the fund.
An emergency fund is crucial for financial stability. In the event of an emergency, it can greatly reduce the strain on your savings and prevent your financial goals from getting disrupted. By using it wisely and replenishing it judiciously, you can maintain your financial freedom and security, even in uncertain times.
The author is DGM Communication, Bankbazaar.com. This article has been published as part of a special arrangement with BankBazaar.