Back when we did not have financial advisors or online banking, workers would save a percentage of their income when bad weather might prevent them from working. It is the origin of the phrase “saving up for a rainy day”. Today, even if the rains prevent us from going to work, our emergency fund gives us peace of mind. In fact, at Fello, we love sitting by the window with a cup of chai on rainy holidays!
The fact is, we all need an emergency fund to meet unforeseen expenses. This reserve fund covers unexpected financial hassles without disrupting your long-term financial goals. After all, the Covid-19 pandemic has taught us that emergencies can happen anytime. It is always easier to tackle unforeseen circumstances knowing you will not have to deplete your savings. As financial expert Dave Ramsey puts it, “An emergency fund converts a crisis into an inconvenience.”
Read on to understand why you need an Emergency Fund, how it helps and how to go about building it through wise investments.
So, What Is An Emergency Fund Or Corpus?
An emergency fund refers to a part of your savings that ensures you have enough money to cover emergency expenses till things improve. It helps in unexpected times, without jeopardizing your long-term financial goals. A true emergency fund is not the same as your traditional savings fund. Hence, the differences between an emergency fund and savings must be well understood.
If you exhaust your entire emergency funds/savings at once, you won’t have any money left over for the next rainy day! Naturally, building an emergency fund cannot be a one-time affair. It must be a constant financial aim, not another source of funding or income.
Now that you know what an emergency fund is, here’s why it’s critical to have one in today’s financial climate.
Why Is It Important To Have An Emergency Fund?
No, Baby Yoda – unless you want another emergency on your baby hands!
Emergencies and the resulting financial burden are unforeseeable. Sure, you can dip into your savings or use your credit cards. Yet, emergencies take several forms. It could be as minor as buying a new laptop or as serious as losing your job. Ouch!
Your emergency could last several months. You still need to manage your everyday expenses and financial obligations, right? An emergency corpus will prevent you from dipping into your hard-earned savings. Moreover, an emergency fund will provide a financial safety net till you get back on your feet – with your savings intact.
We cannot stress the importance of having an emergency fund enough. These funds can get you through dire emergencies without any (major) financial worries. Yet, you must be wondering – how do you define an “emergency” and justify dipping into your emergency funds?
When Should You Dip Into Your Emergency Funds?
Not to state the obvious, but “emergency” funds are only for emergencies. You need to be sure whether a situation demands cracking open the “rainy day” safe. Here are a few situations that justify using your emergency funds.
- The most severe financial emergency is a loss or reduction in income. If you lose your job, emergency funds can be used to cover living expenses such as rent, food, etc. Freelancers and gig workers might do the same for an acute decline in income.
- Another major source of financial distress is medical costs. Despite health insurance, an emergency corpus might be invaluable for sudden medical expenses.
- Most major repairs are often unanticipated and expensive. An emergency fund is a better alternative than using credit cards, as they rack up extra interest charges.
It is also important to note when not to use your emergency funds. This is for you Baby Yoda, take notes!
Emergency funds should not cover recurring expenditures, such as birthday presents, annual subscriptions, mortgage, income taxes, etc. To sum it up – only use your reserve funds for major, unforeseen expenses.
That’s a no-go, folks – no matter how impressive the discount!
Instead, you could divert that money towards investments that help you build an emergency fund.
What Are The Best Investments To Build An Emergency Fund?
Your fully-funded emergency fund should cover recurring expenses for 6 to 9 months. If you have a volatile job or varying income, aim to save 12 months of expenses in your emergency fund. Remember that your emergency fund has to be liquid and accessible on short notice. For example, diverting 40 to 50 percent of your emergency reserves to mutual funds is advisable as they are available within one working day.
Here are some other popular investment options to build a robust emergency fund –
- Savings Account: A savings account enables you to transfer funds and withdraw cash without any delay. Moreover, banks give you a nominal interest on the funds in the savings account. You can store between 15 to 20% of your emergency funds in a savings account.
- Fixed Deposits (FDs): Fixed deposits offer a higher interest rate than a typical savings bank account. This investment option also offers better liquidity as you can cash out fixed deposits on any working day at the bank. Although, through online banking, you can liquidate it even on a bank holiday!
- Liquid Mutual Funds: A large part of your emergency fund can be invested in liquid mutual funds. They carry a lower risk than other debt investments and have no lock-in period. Some liquid mutual funds even offer cash withdrawal facilities up to Rs 50,000 per day. Moreover, these funds deliver a higher return than a savings bank account. And as the name suggests, they are highly liquid!
- Money Market Instruments: This investment offers higher returns than a savings account. Money market instruments also have higher liquidity and are one of the least volatile types of mutual funds. Investment in the money market also offers extra diversification.
- Digital Gold: Digital gold is the simplest and most practical investment. Unlike physical gold, it does not entail storage expenses or making charges. Experts suggest keeping 10 to 15 percent of your emergency fund in gold investments. What’s more, you can get higher returns too!
Building and maintaining an emergency fund is an important aspect of financial planning. If you had to use your emergency fund, don’t forget to replenish it for the next time you are in need. You don’t always hear the lightning before it rains!
After facing an emergency, you might decide to increase your monthly investments or save up more often. The right investment choices will make the process of rebuilding simpler and faster. You can be smarter about it too, by investing in digital gold with Fello.
Did we mention there are tons of cool games and awesome rewards!