Titanic, the most luxurious ship in the world back then, did everything right except being prepared for emergencies. There were more than 2000 people aboard but only 20 lifeboats because it was touted to be an unsinkable ship. However, life is unpredictable. And it is best to be prepared for its uncertainties no matter what. This is where an emergency fund comes into the picture. What is an emergency fund, and how is it important? Let’s find out.
Emergency fund: A fund in need is a fund indeed
An emergency fund is a fund that has your back. You can rely on it for financial support in case of a crisis. You can call it a pool of money that is set aside for varied eventualities, such as job loss, sudden repairs, medical expenses, etc. Thus, it must be a part of your financial planning. Ideally, you should have a fund that covers at least three to six months of your expenses. Also, you must refrain from tapping into the fund for ordinary or regular expenses.
Emergency fund – A must have
The importance of an emergency fund cannot be stressed enough. Here are some reasons why you must have it in place.
- You don’t add to your debts
Imagine facing a financial emergency and having no savings. Naturally, you will resort to borrowing. With an emergency fund in place, you will smartly avoid the debt trap.
- You can live a peaceful life
Financial difficulties can reflect on your health. Stress can be a leading cause of several diseases. An emergency fund ensures you live a healthy and peaceful life.
- You can meet life goals
You should not let emergencies wipe off the savings that you built for your goals. Instead, you must plan for them through an emergency fund.
- You can continue growing your money
Long-term investments help you grow wealth because you benefit from the power of compounding. This means you not only earn returns on your original investment but also on the returns that get added to it. But if you withdraw your investment during an emergency, you deprive yourself of these benefits.
Having an emergency fund is important, but it does not have to be an uphill task. You can be emergency-ready in a few simple steps.
How to build an emergency fund – Tips explained
Different individuals can have different ways of creating their emergency fund. But here are some common steps that can help.
- Create a budget
First, assess your monthly expenses and income – How much you have, how much you spend, how much you save, etc.
- Do some math
Multiply your monthly expenses by three and six. The answers you get will help you determine the minimum amount that your fund must have. Say, if your monthly expense is Rs 20,000. Your emergency fund must always have at least between Rs 60,000 andRs 1,20,000.
- Reassess your expenses and cut down on the same
To build your fund, you must set aside a sum every month diligently. It may not be easy to fill up the fund immediately. However, small lifestyle changes overtime can go a long way in contributing to the fund. For example, if you eat out every weekend, you can skip one or two weekends and save money there.
- Invest what you save
Mere saving a certain amount every month may not be helpful because inflation can drastically reduce its value. Keeping the money in a savings account also may not be very wise because the returns are minimal. Fixed deposits may offer better returns, but they lock your money for a specific period. Thus, from the many types of investments, you must choose the one that not only offers good returns but is also highly liquid. For example, you can consider different debt funds, such as liquid funds and overnight funds. Liquid funds invest in securities with a maturity of up to 91 days, while overnight funds invest in securities having a maturity of one business day. Both these funds are highly liquid and accessible.
To sum it up
An emergency fund is a must-have, given the uncertainties of life. However, you should be able to access your funds at all times. Thus, it is crucial to invest in the right investment options that offer liquidity.
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