An emergency fund is an indispensable part of your personal finances. It is a pool of funds that you keep aside to be used when faced with financial emergencies. These emergencies could range from a cracked ceiling to a slash in pay. Having in place an emergency fund sufficient to carry you over through eight to twelve months of your routine expenses will enhance your ability to tide over these blips and bumps.
Steps to building and maintaining an emergency fund:
- Identify your non-discretionary monthly routine expenses and annual one-off expenses. A robust emergency fund should be large enough to meet your total annual non-discretionary expenses for a year.
For eg, if you need Rs. 50,000 to meet your monthly expenses and Rs. 1,25,000 to meet your annual, one-off non-discretionary expenses, the emergency fund you should target to accumulate will equal Rs. 7,25,000 [( 50000*12)+125000].
2. Store this amount across assets where capital protection is assured. You can use a combination of high-quality liquid funds and fixed deposits to park your emergency funds.
However, there is no cause for panic if you find that at present you do not have enough funds set aside to meet your emergency fund requirement. You can start systematically saving towards this goal today. Rome wasn’t built in a day, was it?
3.When a financial emergency hits, rely on your emergency fund. However, before you dip into this fund, ensure that it is indeed a financial emergency that you are faced with.
A leaky ceiling, an unanticipated medical expense in the family, a pay-cut or being laid off are the very kind of shocks that this fund should see you through. An impromptu road trip because YOLO or splurging on a cute dress because ‘you are worth it’, do not qualify as financial emergencies.
4.Once you are back on your feet, ensure that you prioritise replenishing your emergency fund.
A healthy emergency fund will prevent your long-term financial goals and independence from being sabotaged by unanticipated shocks.
In the absence of an emergency fund, unforeseen expenses may force you to liquidate your financial portfolios at times and prices inconvenient to you. You may even have to resort to availing high-cost credit or borrowing from friends or family, thus risking debt traps and strained personal relationships. An emergency fund can defend you from all these.
For most of us, it is a long road ahead. Your emergency fund is the first aid kit that will help you take care of that split lip till you can find your way to the nearest hospital. It will ensure that you do not have to pull over on a dark stretch of the highway and rely on help that might never come.
By Aparna M
Financial Advisor – PeakAlpha Investments