What is emergency fund and why it matters

Unexpected events in life can affect your financial future. Certainly you can’t plan for everything. However, a little planning will make those emergencies and unexpected events much easier to handle. In other words, you need to prepare for unexpected events in advance. To safeguard yourself from these unexpected events, you need to build up a solid emergency fund.

Unexpected events can be anything which affects your financial condition. Here are few for your reference;

  • Job loss and have a hard time finding another one
  • Unexpected illness due to which you are unable to work for a period
  • Economic downturn
  • Natural disasters
  • COVID-19 – Coronavirus outbreak
  • Anything that might affect your income or create financial emergencies

Building an emergency fund should be part of the financial goals, but many fail to do so.

What is an emergency fund?

When you are younger, you can afford to take more risk. But, as you age, you definitely need more money to take care of unexpected expenses. 

Emergency fund is the money that you accumulate over a period of time to cover your living expenses in case of an unexpected financial blow. 

When something unexpected comes up, money in your emergency fund account protects your financial health. It’s earmarked for spending on true emergencies or for worst case scenarios.

If you are in the stock market, it protects your long term investments in case of high volatility, economic downturn or bear market.

Having money set aside in an emergency fund should be a necessary component of your healthy financial plan. It works as a shock absorber for the bumps in your life.

Many experts call it a rainy day fund, as you are building up the cash for a rainy day.

But, what is the right amount to set aside in an emergency fund?

How much money should you have in emergency fund?

As a rule-of-thumb, your emergency fund should be enough to take care of at least 5 to 6 month’s standard living expenses. If you are a single income family, an emergency fund should be created to fund expenses for a year.

For example, if you need Rs 25,000 per month to live comfortably, then your emergency fund should have at least 1,50,000 rupees in safe and easily accessible investments to take care of 6 months living expenses.

To know exactly how much you require, you need to calculate how much you are spending on a monthly basis. If you are married, then put extra money to take care expenses of your spouse and children.

To make it easier, experts advise setting up a dedicated bank savings account to accumulate funds on a regular basis. If you are aiming for 1,50,000 rupees in an emergency fund account, then try accumulating Rs 10,000 per month to create the cash reserve.

You can change the monthly contribution based on what you are comfortable putting away. 

Here are few steps to set up your emergency fund;

  • Calculate your monthly living expenses.
  • Multiply monthly expenses with the number of months for which you want your emergency fund to set up. If you want for 6 months, multiply your monthly total expenses with 6.
  • Decide how much you would like to save based on your income. While deciding, you should make sure you work to your comfort level.
  • After determining how much you want in your emergency account, go and open a dedicated saving account in a bank.
  • Set a monthly saving goal and deposit money regularly to the account.
  • To make it easier, move money into your saving account automatically. You can activate automatic deposits option from your salary or regular income account to your emergency fund bank account.

Who needs an emergency fund?

Many argue, Why do I need an emergency fund when my employer doesn’t have any issues and the economy is doing well.

Well, we all need to have an emergency fund in order to secure our financial health incase of uncertainties. 

Here are top 5 reasons why you should have a rainy day fund;

  • In order to protect your family in case of job loss
  • To reduce stress in case of uncertainties
  • Creating a cushion for use in case of emergencies
  • To keep a reserve for health or other family emergencies
  • To protect you during the down market. As you are not required to sell your stocks to take care of living expenses in case of market uncertainties.

You should keep your rainy day fund in such a place which can easily be accessed.  You can keep it in your bank account or in risk free liquid investments.

Is rainy day fund enough to secure you financially?

How far the money kept in a rainy fund account can help you in emergencies depends on how big it is.

If your emergency fund is not enough to take care of your medical bills and repair of car and other assets etc, you can get insurance to cover your health, home, car and your life.

You should make sure that you have adequate life insurance. If you have home loans or any other major debt, make sure the value of the policy’s death benefit is enough to pay off the debt after you pass away.

If the present job is not contributing to create enough money to your emergency fund account, try a second job. Working extra hours can make a big difference in contributing to your financial health. You can make money online through a blog, YouTube Channel or by selling your expertise.

is a fellow member of the Institute of Chartered Accountants of India. He lives in Bhubaneswar, India. He writes about personal finance, income tax, goods and services tax (GST), company law and other topics on finance. Follow him on facebook or instagram or twitter.