The Importance of an Emergency Fund

Prabin Agarwal
Founder & CEO, Prabin Agarwal - Empowering Investments

One of the important money lessons that this pandemic has taught us is the importance of having an emergency fund. Very often, investors have plans for their children’s education and their own retirement but ignore creating an emergency fund to tackle the uncalled for situations in life. The pandemic brought to light various emergency situations such as lay-offs, pay-cuts and growing medical expenses that one could possibly face but never accounted for during financial planning.

What is an Emergency Fund? : An emergency fund is essentially a kitty set aside solely to cover any unexpected event(s) in life. These emergencies can include situations such as delay in salary, a temporary pay-cut, an accident leading to disability due to which a person cannot work temporarily, sudden loss of job, hospitalisation of self or a family member, home repairs due to a natural disaster, unanticipated vehicle repairs or any other situation in which you need more money than usual. The idea behind creating an emergency fund is to help address time-critical requirements in life. So, a trip to Mal-dives does not count.

Importance of Emergency Fund : The presence of an emergency fund is an investor’s bail-out option during tough times, without having to disrupt one’s savings goals. If Financial Planning you do not already have an emergency fund, then setting it up should be your first financial goal. It puts you in control of life’s unexpected twists and turns, no matter what crisis you have to face. By having an emergency fund, your finances will be one less thing to stress about during an already uncertain time.

Creating an emergency fund provides you with a safety net when times get tough. Instead of banking on a high-interest loan or using a credit card, emergency funds allow you to pay for life’s necessities interest-free. In case you are already servicing loans then having an emergency fund ensures you do not need to borrow any more money. When dipping into an emergency fund, remember, once the situation normalises, you have to rebuild the corpus of the fund to be future-ready once again.

Emergency Fund Amount : Such a fund should accommodate a minimum of six months of one’s fixed expenses such as basic living expenses like rent, groceries, healthcare, utilities, transport, insurance premiums and loans. In a post-pandemic world, it would be wise to increase the safety net amount to up to a year.

Building an Emergency Fund? : Make sure your emergency fund is clearly demarcated from the rest of your investments. It should be saved in an instrument where the funds will be readily accessible whenever the time arises. It is important to remember that emergencies happen when you least expect them, so be disciplined when it comes to creating an emergency fund. Creating such a fund is not a one-time activity but needs reviewing at periodic intervals such that it can match up to the changes in one’s lifestyle and inflation. Some of the investment instruments you can tap into for creating an emergency fund are short-term debt mutual funds or liquid funds or a simple savings bank account. Liquid and ultra-short-term debt funds tend to be lower on the risk profile as these funds largely invest in treasury bills, government bonds, etc. and are not mostly non-volatile in nature.

By investing in debt mutual funds, while the amount remains invested you can make some gains off it as well while being a tax-efficient option. Remember to opt for the growth option of these funds. The instant redemption facility (offered by some fund houses) makes liquid fund more competitive when compared with bank savings account as the interest rate offered is very low. However, keeping a portion of emergency fund in a savings bank account is another option one can consider.

To conclude, emergency fund as the name suggests should be tapped into strictly during crisis periods only. Risk-free returns and easy access to corpus created should be your top priorities when choosing an investment option to save your emergency fund. And finally, always remember to keep your emergency fund in tune with the changing times of one’s life and require-ments

The writer is the Founder & CEO, Prabin Agarwal - Empowering Investments
 Email: prabin@prabinagarwal.com
 Website: www.prabinagarwal.com