How To: Build Your Emergency Fund

What is an emergency fund?

An emergency fund is your financial life raft. It is an easily accessible sum of money that can help you anytime. Given our lives’ unpredictable nature, an emergency fund is an absolute must. An emergency fund should be in a place where it can be accessed and put to use instantly. There are two broad ways one can look at building emergency funds. The more popular kind of emergency fund considers expenses. The conservative fund considers income.

Arriving at your emergency fund

So, how much money should your fund even have? A basic emergency fund covers three months of expenses. Think about it this way – if you were to lose all your income tomorrow, for whatever reason, how much would you need to get through 3 months? So you can add up all your monthly expenses, namely, rent, utilities, healthcare, internet, groceries, subscriptions and anything else that you might consider essential. Then, you multiply it by 3 to arrive at the end amount.

An easier calculation (but a more difficult target) would be to multiply your current income by three. This will take longer to save but will provide a greater cushion.

Is three months enough?

Your mileage may vary. If you want to play it safe, you can aim to hit 6 months of expenses or 4 months of income. But three months of expenses is generally the recommended starting amount for an emergency fund.

Saving strategies for emergency funds

Putting together 3 months of expenses or income can seem daunting. But if you can be slightly aggressive with how you save or try budgeting to cut down on unnecessary expenses, you can reach your goal faster than you think. Given that having an emergency fund is a priority today, you can also consider adjusting some of your savings from your long-term savings, if any. If you have money in mutual funds, for example, you could redeem those. Alternatively, you can pause your SIPs to accumulate your funds.

Where do I park my fund?

Your emergency fund should be in a place that’s easily accessible. Consider a situation where you might have to produce money for a hospital advance, for example. Your bank account is one place to hold it in. But if you’re afraid you might end up spending it, you could park it in an FD. Another option is to put it in a separate, high-interest bank account (IDFC & Suryoday Small Finance are 2 banks that offer these accounts, among others). You could also park it in overnight mutual funds, which can offer a marginally higher rate of return while ensuring the ready availability of funds.

Make it a priority

We continue to live in very uncertain times. Medical expenses can arise at any time. And you never really know when an emergency can strike you. So, being prepared can save a lot of stress (and heartache!) during difficult times. If you haven’t had the chance to build your emergency fund yet, consider prioritising it immediately.