What will you do if you lost your job tomorrow? Will you be able to pay the rent for next few months? Will you have the money to manage day-to- day expenses of your family? Will you be able to pay the school fees of your children?
If the answer to all or some of the above questions is a ‘No’, then you are committing the mistake of living on financial edge. You are unprepared for the unexpected.
The solution to this problem is having an emergency fund. This fund can be the most vital part of your financial plan. So it’s imperative that you make one for yourself, as soon as possible.
Now the main purpose of an emergency fund is to create a financial backup during emergencies like an illness, job loss or other unexpected expenses like home or car repairs. Another benefit of having an emergency fund is that you can avoid taking credit card debt or personal loan when you need the money. This helps save on the high personal loan interest rates. But this fund is not to be used for planned expenses like a house, car, etc. It has to be necessarily earmarked for use in only emergency.
Once you agree in principle with the importance of having an emergency fund, the question arises that what amount should be saved in this fund? Experts are of view that the minimum that one should target, is to have 6 months worth of family expenses in the fund. But the exact amount will depend on an individual’s financial situation. If a person is the sole earning member of family, then amount should be higher. If your spouse is working, then the emergency fund can be smaller too. Nevertheless, 6 months’ expenses worth of fund is a good target to work towards.
The next question is where to put that money?
A very important factor in this decision will be that funds should be available on an immediate basis, when required. There is no point having an emergency fund that can only be accessed after a few days. Hence there is absolutely no point in putting your emergency funds in stocks or mutual funds.
You need to keep your emergency fund as liquid as possible. One should not try to earn higher returns on this fund, as this fund is not for wealth creation but a buffer for emergency. The best approach would be put it in easily accessible bank accounts. But once again, it depends ultimately on what you are comfortable with. So make sure that you start working towards creating a big-enough emergency fund for yourself. It might be the most important thing you would be doing in personal finance to handle emergencies, without resorting to use of personal loans.
