In a world full of uncertainties, having an emergency fund has become a necessity. Unexpected expenses can arise at any time, and having a safety net in place can help you avoid financial stress and uncertainty. But how much should you be saving in your emergency fund? Is there a magic number?
In this ultimate guide, we’ll explore the ins and outs of building an emergency fund, including how much you should be saving, where to keep your funds, and what expenses to consider. Whether you’re just starting out on your financial journey or you’re a seasoned saver, this guide will provide you with the knowledge and tools you need to build a robust emergency fund and feel confident in your financial future. So, let’s get started!
Table of Contents
- Why Do You Need an Emergency Fund?
- How Much Money Should You Save In Your Emergency Fund
- Determining Your Monthly Expenses
- Creating An Emergency Fund
- Where To Keep Your Emergency Fund
- Tips to Grow Your Emergency Fund Faster
- What To Do if You Don’t Have an Emergency Fund
- When to use Your Emergency Fund
Why Do You Need an Emergency Fund?
An emergency fund is a financial cushion that you can use in case of unexpected expenses or a loss of income. It’s a safety net that can help you avoid debt and financial stress. Without an emergency fund, you may have to rely on credit cards or loans to cover unexpected expenses, which can lead to high-interest debt and financial instability.
An emergency fund can also provide peace of mind. Knowing that you have a buffer in case of an emergency can reduce stress and anxiety. It can also give you the confidence to take risks, such as starting a new business or pursuing a career change, knowing that you have a financial safety net.
Lastly, an emergency fund can help you maintain your lifestyle during a financial crisis. If you lose your job or experience a reduction in income, your emergency fund can help you cover your basic living expenses until you get back on your feet.
Recent outbreak of worldwide pandemic coronavirus by covid-19 virus is an example of financial emergency where people have been left locked to their homes. There is so much of employment loss and people are left to the mercy of the authorities, even to get food to stay alive, under lockdown. That has exposed how much number of people are unprepared to handle the financial emergencies even for few days of time.
How Much Money Should You Save In Your Emergency Fund
One of the most common questions when it comes to building an emergency fund is how much you should save. The answer varies depending on your financial situation, but a general rule of thumb is to save at least three to six months’ worth of expenses.
However, this number can vary depending on your job stability, health, and lifestyle. If you have a stable job and good health, you may be comfortable with a smaller emergency fund. If you’re self-employed or have an unstable income, you may want to save more.
It’s important to remember that the goal of an emergency fund is to provide a safety net during times of financial instability. So, if you have a lot of debt or are in a precarious financial situation, you may want to save more than six months’ worth of expenses.
Determining Your Monthly Expenses
Before you can determine how much to save in your emergency fund, you need to calculate your monthly expenses. This includes your housing costs, food, transportation, utilities, and any other bills or expenses you have.
To calculate your monthly expenses, start by listing all of your bills and expenses for the month. Add up all of your fixed expenses, such as rent or mortgage payments, car payments, and insurance premiums. Then, add up your variable expenses, such as groceries and entertainment.
Once you have a total for your monthly expenses, you can multiply that number by three to six to determine how much to save in your emergency fund. For example, if your monthly expenses are $3,000, you should aim to save between $9,000 and $18,000 in your emergency fund.
Creating An Emergency Fund
Now that you know how much to save in your emergency fund, the next step is to start building it. You can start emergency fund building process with a strong will, effort and time. You would have to maintain a discipline in your financial management. Here are some tips to help you get started:
Set a Savings Goal
Setting a savings goal can help you stay motivated and on track. You need to decide on a target amount and a timeline for reaching that amount. For example, you may want to save $10,000 in your emergency fund within the next year.
Create a Budget
Creating a budget can help you identify areas where you can cut back on expenses and free up money to save. Review your expenses and find the ones making a big hole in your pocket. Auditing of income and expenses is very important to achieve the goal of savings.
Look for ways to reduce your monthly expenses,. You will find so many ways of saving money like cancelling unnecessary subscriptions for services you might not be using, cable or dish tv channel packs which you are not interested in watching, disconnecting rarely used landline telephones if you have mobile phones and eating out less often.
Automate Your Savings
Automating your savings can make it easier to save consistently. Set up a direct deposit from your paycheck into a separate savings account designated for your emergency fund.
You should make a habit to save some amount from your income regularly and build savings. Ideally, you should save at least 25% of your total income regularly. Keep putting that money in a separate bank account which you normally do not use for withdrawals.
The purpose of building an emergency fund is not to make your life miserable but to bring a financial discipline and financial security.
Starting small can help you build momentum and develop good savings habits. Even if you can only save $50 a month, it’s better than nothing. Over time, you can increase your savings rate as you get more comfortable. Start allocating money regularly and see you emergency fund building up.
If you are already under a debt, you should also focus towards clearing that debt. In that case, your both tasks should be going on simultaneously. You cannot afford another debt if you face another financial emergency in the meantime.
Insurances are the instruments to take care of emergencies. In the event of any sudden expense, you can simply take the advantage of insurance covers. That can save your emergency fund from such expenses. Multiple insurances are available for different requirements. There is health insurance for illness, auto insurance for vehicular repairs, travel insurances to cover expenses related to travelling and term insurance or life insurance to cover the loss of life.
Where To Keep Your Emergency Fund
Once you’ve started building your emergency fund, you need to decide where to keep it.
Well, the answer is the best place to keep it is where it is easily and readily available at the time of need. Additionally, it yields good returns so that you can earn some income on it also.
Thus, you can divide your funds into two types of emergency funds to fulfil the dual purpose of getting high returns as well as easy and quick availability :
Short Term Emergency Fund
Keep some part of your emergency fund in a regular savings account. The high interest rate savings account is the best savings account for emergency fund. Compare savings account interest rates from different banks and find the best one for you.
The money in savings account should be available for withdrawal at any time. It will be yielding less interest rates, but quick availability is more important than income on our holdings.
Long Term Emergency Fund
There are good options where you can put your long term emergency fund :
Major part of the emergency fund can be invested in debt instruments or liquid mutual funds. The advantage of keeping money in these accounts is that they yield better returns with nil or little risk. Thus, they help your money grow when it is not needed.
In case of an emergency, you can get your money in 24-48 hours. By that time, you can use the money you put in your savings account.
1. Liquid Funds
Liquid funds are debt mutual funds. Debt mutual funds are low risk category money market funds with almost nil risk to your money. However, they yield good returns. Most of the funds usually an earn you 7-8% annual return which is even better than some fixed deposits after tax deductions. There is no entry load. The funds can be redeemed anytime without any penalty or exit load. You get money in your account normally in one business day.
Liquid funds are the best place to invest money for 1 year or less. You can invest in liquid fund in systematically investment plan (sip) route by putting small amount regularly and systematically.
2. High Yield Bank Accounts
Some institutions offer high yield bank accounts which offer higher interest rates than normal savings bank accounts. They are high interest rate accounts along with the added advantage of money being always available to you. You can inquire about the high yield accounts in the banks in your area and opt to put your emergency fund in a high yield bank account.
3. Certificate of Deposit (CD)
A certificate of deposit (CD) is a type of savings account that pays a fixed interest rate for a set period. CDs typically offer higher interest rates than savings accounts but may require you to lock up your money for a specific period.
CDs are popular way of saving in India as fixed deposits (FDs). These FDs are offered by banks as well as some private institutions. The later offer better interest rates than public banks.
Tips to Grow Your Emergency Fund Faster
If you want to grow your emergency fund faster, here are some tips to help:
- Increase your income: Increasing your income can help you save more money. Look for ways to earn extra income, such as taking on a side gig or asking for a raise at work.
- Cut expenses: Cutting expenses can also help you save more money. Look for ways to reduce your monthly expenses, such as canceling subscriptions or negotiating your bills.
- Use windfalls: If you receive a windfall, such as a tax refund or bonus, consider putting that money towards your emergency fund.
- Invest: Investing your emergency fund can help it grow faster, but it also comes with more risk. Consider investing a portion of it in a low-risk investments, such as a bonds.
- Sell The Unwanted Items: Every house has something lying idle which is of no use. It can be old mobile phones, computers, furniture. You can sell them offline or on online websites like ebay, olx and earn money. Put that money into your emergency fund and move towards your goal faster.
What To Do if You Don’t Have an Emergency Fund
If you don’t have an emergency fund, don’t panic. Here are some steps you can take to start building one:
- Start Saving: Start saving as soon as possible, even if it’s only a small amount. Every little bit helps, and over time, your emergency fund will grow.
- Create a budget: Creating a budget can help you identify areas where you can cut back on expenses and free up money to save.
- Prioritize your savings: Make saving for your emergency fund a priority. You need to cut back on non-essential expenses and put that money towards your emergency fund.
When to use Your Emergency Fund
Knowing when to use your emergency fund is just as important as building it. Here are some situations where you may need to use it:
- Job loss: If you lose your job or experience a reduction in income, your emergency fund can help you cover your basic living expenses until you get back on your feet.
- Medical expenses: Medical expenses can be a significant financial burden. If you have an unexpected medical expense, your emergency fund can help you cover the cost.
- Home or car repairs: Home and car repairs can be expensive and unexpected. Your emergency fund can help you cover these expenses without going into debt.
- Family emergencies: If you have a family emergency, such as an unfortunate death in the family, your emergency fund can help you cover travel expenses and other costs.
If you have to use your emergency fund, it’s important to rebuild it as soon as possible.
To conclude, building an emergency fund is an essential part of financial planning. It can help you provide peace of mind, avoid debt and financial stress. Thus, you can maintain your lifestyle during a financial crisis also. While there is no magic number for how much to save in your emergency fund, a general rule of thumb is to save at least three to six months’ worth of expenses. By following the tips in this guide, you can start building your emergency fund and feel confident in your financial future.