A couple of years back, no one would have imagined that virus would change our lives forever, as we have seen in the year 2020. Fear of infection, lockdown, and social distancing norms have drastically altered all our behaviors, creating a new way of life which we call the new normal. With the present state of affairs, it has become inevitable to have an emergency fund, a tool that will help you manage the unwelcome impacts of the pandemic.
“Great emergencies and crises show us how much greater our vital resources are than we had supposed.”- William James
All of us are familiar with the concept of emergency and might have experienced it in various forms at different points in our lives. An emergency can be defined as a sudden, unforeseen happening which calls for immediate action, neglecting which can cause serious repercussions in our lives. Setting aside some amount of money can help us prevent such situations from getting disastrous. A pool of money set aside to meet such expenses is known as Emergency Funds.
Emergency funds play a crucial role in our lives due to a variety of reasons. Let us now go in-depth into some of those reasons:
i. It helps us stop adding debt: Have you ever come across a situation where you fell ill unexpectedly/ had to take your car for repairs and realized that you did not have sufficient cash to pay for it? Well, this would have been the exact point you wished you had kept aside some money as an emergency fund. An emergency fund provides enough funds to take care of uncertainties and enables us to cover the expenses that we had not budgeted for, thereby eliminating the chances of running into/ adding on to debts.
ii. It helps us cover expenses that were inadvertently left out: Can you recollect an instance when you accidentally missed out on some of the expenses that you should have planned for? Regularly maintaining a small amount as an emergency fund can help us cover such expenses. This will give you an idea of how to go about planning your future expenses.
iii. It helps us lead a peaceful life: All of us go through ups and downs in our lives. Life is uncertain and there can be situations where we decide to quit a job we loved, say, due to some personal problems. Having a substantial sum of money as an emergency fund provides ample funds and enables you to lead a peaceful life irrespective of the situation you are in at the moment.
Let us now look at some of the tips to create an emergency fund
i. Chart monthly income and expenses: At times, we might have an idea of our monthly expenses but be clueless about how much we spend on minor expenses like food and transportation. Make a habit of tracking your weekly income and expenses regularly by maintaining a Weekly Expense Tracker. This will allow us to get a rough idea of where our money goes, and how much we spend on emergencies.
ii. Set your emergency savings goal: An ideal emergency savings should be sufficient to cover 3-6 months of actual living expenses. Those with a stable income can very well manage with a slightly lower amount. But those who are likely to reach their credit limit may have to save more.
iii. Develop a plan to start saving: Once a goal is set, you need to come up with a plan to help you achieve those goals. Setting a plan, followed by a periodic review of its progress helps us, identify deviations, and stay on the right track.
iv. Put your emergency fund in an accessible place: The best place to keep your emergency funds in a liquid account (accounts where one can easily access cash. Liquid accounts can either be a regular savings account at a bank or a credit union that provides a return on the deposit, which gives you the flexibility to withdraw those funds at any time without penalty.
v. Stick to your plan: Achieving any goal requires you to adhere to the plan you set to achieve that goal. All of us are familiar with the concept of SMART goals, which stands for S- Specific, M- Measurable, A- Achievable, R-Realistic, and T- Time-bound. Sticking to the plan becomes easy if you’re your goals are SMART. Those who already have a saving habit will find it easy to stay on track.
HOW MUCH SHOULD ONE SAVE?
Several factors decide the size of one’s emergency fund such as one’s income, lifestyle, number of dependents, existing fund, etc. But if we go by general rule, our emergency savings should be anywhere between 3- 6 months worth of our household expenses. However, in case you are the only breadwinner of your family comprising of yourself, your spouse as well as kids, it is recommended that you maintain an emergency fund that is ideal to cover the 12- month’s expenses.
EMERGENCY FUND SAVING THE DAY
The stories of Emergency Fund saving the day are plenty. Once, a Reddit user shared his experience of how maintaining an Emergency Fund led to a substantial financial gain when his wife lost her job, with her company owing to her a large sum of money. They managed to live a decent life although the company offered her only 20% of the amount due. And all this became possible because of the emergency fund the couple had set aside for the past six- months.
To conclude, therefore maintaining a pool of money as Emergency Fund helps us sail through uncertainties. One can decide how much to save depending on one’s income, lifestyle, the number of dependents, etc. However, how to create the fund is purely our choice and one can do so based on the best available option.
“Nothing helps you sleep better at night than knowing you have money tucked away for an emergency.”
- Greg McBride CFA
Idea & Concept: Suvin David, Research Analyst / Faculty
Content Development: Aswathi Satish, Niyog Consultancy Services Pvt. Ltd.