Whether it is a sudden medical expense not covered by your insurance or an expenditure you cannot avoid making, and emergency always comes unannounced. Unfortunately, emergencies are not entirely avoidable. But saving for a rainy day early on can help you to tide over such a crisis easily.
Not sure what’s the right amount to save for your emergency fund? Here’s what you need to know:
What is an emergency fund?
As the name suggests, it is a corpus of funds at your disposal that can be used to overcome an emergency. Any expense that falls outside the purview of routine or expected expenditure can be called an emergency expense.
It is distinct from your regular or retirement savings because it should be treated as a safety net you can fall back on when you suddenly need liquid funds. In fact, having a standalone emergency fund also ensures that you don’t liquidate other long-term savings.
Anyone planning to ave for an emergency fund should understand there is no one-size-fits-all. No two emergencies are the same and what’s the ideal amount to save depends largely on your lifestyle and how much you can afford to save.
What is the ideal amount for an emergency fund?
As a rule of thumb, most personal finance experts recommend saving anywhere between three and six months’ worth of expenses. However, this is not the ideal amount for everyone. For instance, if you have a steady source of income, don’t have too much debt, don’t have anyone who’s financially dependent on you, and your expenses are relatively fewer, you can get by with saving only worth three months’ expenses. But if you don’t have a stable job, have kids or spouse/parents who are financially dependent on you, your daily expenses are fairly high, etc., you’d need to save at least six months’ worth.
The best way to work out how much you should save is by taking into account your risk factors and calculating the monthly expenses that you’d still need to pay for even in an emergency. And once you know the minimum amount you’d need every month to get by during an emergency, you can multiply that with the number of months you would need to save for. For example, if your monthly expense is INR 50,000 and you need an emergency corpus for three months, you need to save INR 1,50,000. If manual calculations are not your cup of tea, you can try out one of the online calculators available. You need to answer a few questions to get the calculator to come up with the optimal amount you need to save.
You can also adopt a two-step approach to save for an emergency fund. If it feels too overwhelming to save such a huge amount every month, set a smaller goal and save towards that. Once you hit the goal, increase the saving amount. Doing so will help you get comfortable with the idea of saving.
To sum up, only you know your financial situation and risk factors best. Therefore, only you can work out the appropriate amount that will help you stay afloat during an emergency.
Where should you invest?
First up, your emergency funds should be available for immediate withdrawal. That’s why parking your money into schemes where you cannot exist before the expiry of a specific time period or have to penalty for early exit is not advisable.
Spreading your emergency fund across short-term RDs, debt mutual funds, and other liquid funds is an excellent way to go about it. When investing in mutual funds, check whether the fund house provides an instant redemption facility to have access to your money any time you want. It is also important to pick saving avenues that will give you a high-interest rate. Make sure that your returns are higher than what a regular savings account or fixed deposit offers.
Lastly, it is not advisable to park your funds in extremely high-risk instruments for emergencies. Building slowly and consistently is more important than trying to make your corpus overnight with a real risk of losing it all. Always remember that an emergency fund cannot be created in a blink of an eye. As long as you are making progress, you are doing fine.
Start building your emergency fund right away
Finding yourself in an emergency without access to money can be a nightmare. Luckily, there are ways to avoid it. Even though building an emergency fund might mean reducing your avoidable expenses to make more room, it can save you when things take an unexpected turn.
So start working towards your emergency fund right away. You may not have control over how life unfolds but having a sense of security about your finances is unparalleled!