With the latest COVID-19 crisis looming over our heads and the whole of India getting locked down, the economy, businesses, and budgets are taking a severe hit and this has led to a wide spectrum of our population getting financially affected. These uncertain times are a good time to keep your finances in check and this is why most people give importance to building an emergency fund.
What is an Emergency Fund?
An Emergency fund is a bank account with at least 3-6 months of income set aside ideally to cover large unexpected expenses like unforeseen medical expenses or unemployment. However, any amount of money even as less as 5% of your income is good to start with.
Building an Emergency fund creates a financial buffer that can keep you afloat in a time of need, without having to rely on credit cards or high-interest loans. This can also help especially when you actually have debt because it can help you avoid borrowing more.
How Much Money Should You Save in an Emergency Fund?
While a few say having two month’s salary in your savings account as ideal, multiple experienced financial advisors recommend you maintain an emergency savings reserve big enough to cover three to six months of household expenses.
The amount of money needed to invest in an emergency fund is quite high, however, we live in times with uncertain economic climates. Emergencies such as disabilities and sudden illnesses, travel and car maintenance, could be expensive and are almost never planned for or welcomed. Financial planning becomes crucial in these unfortunate and unpredictable times.
While it is safe to say we don’t have an extra 3 months income lying around, everything is relative. Saving even 6 months’ expenses is a small number versus the amount needed to be saved for retirement; there’s not a savvy investor out there who looks down on the idea of saving so much money that they never work again.
To ensure your emergency fund is available when needed, you must identify true emergencies and this calls for some serious and effective financial management. These are situations that need some kind of immediate action which could affect your long-term wellbeing or impact an important asset’s viability like the home or car.
How to Build an Emergency Fund?
Save Your Spare Change
Get your entire family to empty out their change from their pockets into a savings jar by the end of the day. These should include all notes and coins. At the end of the month, take the money in your jar and place it in your emergency fund. Use the technique again to boost the fund, but don’t rely on it overtly in achieving the goal.
Pad the Fund Using Dividend Earnings
Don’t view dividend stocks as just stocks for income investing. They are highly recommended in padding the emergency fund investment. Build your portfolio using dividend stocks, and deposit the dividends in the emergency fund. It is not the fastest way to fund the emergency account, however, so ensure you’re dipping your toes in other ponds as well.
Use ‘Wasted’ Money
A few estimates highlight each household wastes upto 10% of their income every month. Seek out these wastage in your budget, like over-ordering at restaurants or leaving the lights on when leaving your rooms. Plug the leaks and use this saved money to add into your emergency fund.
Turn on Auto-Transfers
Schedule regular transfers from your salary to your savings account or emergency fund using your bank’s automated savings tools. You could also have a portion of the pay check diverted to the emergency fund. This way you don’t need to remember to trigger this each month.
The general rule of thumb is to take an aggressive approach to increase your savings and once this is achieved, don’t feel bad about spending money when and where it is actually required since this is why we are building an emergency fund in the first place.