What is Emergency Fund? What is all you need to know about it?

While we plan our personal finances, we have all things sorted like insurances, FDs, Retirement fund, Children’s education and marriage fund, Funds for the house, etc… but do we even plan what if everything comes to a standstill and we’re somehow unable to contribute towards all the funds we planned for. Just a recent example of the pandemic situation that got us locked up in our houses and landed some in the hospitals and some even lost their lives. Possibly every living being got affected by the pandemic. This is when an emergency fund comes in place.

An emergency can strike at any time and we cannot predict how long it may prevail, all we can do is be prepared for it by having an emergency fund. The recent pandemic is just an example; there are other uncertainties that we ought to be safe from like natural disasters, man-made disasters, etc

What is an emergency fund?

An emergency fund is a certain amount that is kept aside in liquid asset form for unforeseen circumstances that might happen in the future. Basically to set yourself and your family risk-free financially in the time of emergencies by having an accumulated amount, that you can lay on without having to look out for unplanned loans, breaking years-long FDs, or asking people around for the same.

It works like a parachute and is supposed to be opened only at the time when you’re plunging. For example, emergency medical expenses, emergency repairs, unexpected travel, unexpected termination at work, etc. Ideally, anything that is unavoidable and qualifies for obligatory expense comes under the emergency fund category. However, obligatory expenses differ as per preferences but the bottom line remains that there should be some amount accumulated that qualifies under obligatory expense.

How much is ideal to save?

No one can predict the kind of emergency that you’ll come across or for how long it may prevail. The number of emergency funds will be subject to your lifestyle, the expenses of the dependents in your family, medical expenses, etc. Take into account the obligatory and discretionary expenses in your household and sieve the unnecessary ones. So the ground rule for this is to put away ideally 3–6 months' worth of expenses aside.

The expenses will include the following:

• Electricity bills

• House rent/ EMIs

• Water and gas bills

• Food, groceries, and dairy

• School/ College fees of children

• Medical expenses

• Commuting expenses

• Insurance premiums

• House maintenance expenses

• Domestic help expenses

• Other, if any

Considering all the above-mentioned expenses, a total of these multiplied with the number of months you’d like to have an emergency fund for is the amount you should save.

For instance, if a family of four has one earning member and the monthly expenses cost about 40,000 per month then for 6 months of emergency fund they’ll have to keep aside a sum of 2.4 Lakhs. Now, this may seem huge and daunting at the beginning but you can save up little at a time to make this fund for your emergencies. The amount of expenses is obviously subjective for each household and so it may vary according to the family needs, job stability, other obligations, other factors, etc.

The personal finance experts suggest putting fixed expenses for one year and variable expenses amount aside for at least six months. Also, the amount kept aside varies depending upon the earning members in a family.

Where to put this money?

The emergency fund should be best put in interest-earning savings bank account or liquid mutual funds. The purpose is, have easy access, hassle-free process to the funds at the time of emergencies. The processing time in these is null and so it makes your fund easy to grab during emergencies. While the issue putting this among in high earning schemes like FDs and equity, debt, or Government bond instruments is it will not only increase the processing time but also may lose some value if withdrawn premature, which we definitely do not wish for.

Points to consider before parking your emergency fund money:

• Safety and security

• Easy withdrawal/ Access at any time

• Hassel free procedure

• Segregation of Investments and Emergency Funds

• Consider Taxes

Parking options for your emergency funds:

• Cash

• Savings Bank account

• Short term fixed deposits

• Liquid mutual funds

When to use it?

The ultimate objective behind having these funds is explained in the name itself, it’s during any emergencies and so is to be done. Having said that, if any emergency pops up and we tap the money for withdrawal is fine but starting to rebuild it again immediately is also important. You never know how long it will go and save you at the time of another emergency by meeting you and your family’s needs.

The bottom line is when you plan your personal finances and are saving up for various goals, set your first priority for an emergency fund as we cannot predict what our future has in store for us but all we can do is be prepared. The importance of having an emergency fund can’t be stressed enough but one can realize it only when it comes in handy at the time of financial crisis.

Lastly, it is important to review that yearly at least so that you’re tracking the changes that have happened in your family that might require a change in your emergency fund balances.