Sooner or later, every one of us will face some financial turmoil, be it in the form of an unanticipated medical bill, loss of income, car accident, home repair, or even broken cell phones. And, without proper planning, even the tinniest financial emergencies can make a massive dent in your savings and future plans.
Therefore, it becomes important that we have a viable financial support system, in other words, an emergency fund at our disposal.
What is an Emergency Funds?
An emergency fund or contingency fund is an amount of money saved specifically to deal with unexpected life events including:
- Unforeseen medical expenses
- Sudden major house repairs
Moreover, in case of job loss, it can provide you with better financial stability. Thus enabling your to venture off for better employment opportunities.
And without any set-aside fund to back in case of emergencies, liquidating your investments, taking personal loans, and asking relatives or friends for money are the only options you are left with.
How Much Money to Keep In Your Emergency Fund?
According to the general rule of thumb, a sum of at least six months of expenses as a contingency fund is a good starting point. And as you proceed, you can continue taking the amount for up to twelve months.
However, many other factors also contribute to deciding the total sum of your emergency fund. For example, professionals working in government or top-tier private organizations enjoy relatively more job security than those with unstable sources of income. Seed-stage entrepreneurs or freelancers, for instance, have a higher likelihood of losing their job or bearing more losses.
Therefore, before deciding on the sum, take your job security into consideration. For professionals with lower job security, try to keep at least 8-12 months of expenses reserved for emergencies.
You can also choose to split your emergency funds into two categories:
Short-Term Emergency Funds
Such funds usually account for 25% of your entire emergency funds. Therefore, short-term funds are parked not in terms of returns but accessibility because, in the case of extreme situations, this amount can suffice until you get a hold of your long-term emergency funds.
Long-Term Emergency Funds
This constitutes 75% of your total crisis fund. Here, you do have the liberty to invest the amount for some better interests, but it should also not take more than a day to liquidate.
How to Build an Emergency Fund?
Putting aside thousands of dollars might look like an enormous task. But, by intelligently planning your finances and building your fund one brick at a time, you will get there without any hassle.
So, here are the top 5 tips to get the ball rolling:
Set a Monthly Goal: Now that you are clear on your initial emergency fund amount, it’s time to split your goal into tiny weekly and monthly deposits. Setting aside a small amount at a time allows you to build your emergency fund without cutting your significant expenses.
Automate the Process: Automate the deduction of a certain amount from your saving to your emergency funds every month as soon as you receive your pay.
Cut Unnecessary Expenses: As the amount in your emergency fund increases, it is natural to have a feeling of financial security. But don’t let this feeling creep into unnecessary spending habits. Thus, stay away from increasing your monthly spending and don’t open new credit cards while saving for emergencies.
Don’t Over-Save: Don’t put all of your savings into emergency funds. And, once you have reached the set amount for savings, start investing the reoccurring amount in places where it will start earning money of its own.
Park Your Funds Wisely: There’s no use of an emergency fund if you cannot liquidate it in times of crisis. Therefore, park your money wisely so you can still fetch at least some returns, but also liquidate it if the need be.
If achieving your goal seems challenging, try not to get overwhelmed. Just keep in mind that you won’t need it all at once or even in a year.
Consider your emergency fund as a continuous process, similar to your retirement savings account. Once you succeed in achieving it, you’ll have additional cash each month to use for other objectives.
Where to Park Your Emergency Fund?
Now, the next question that falls is where you should park your emergency funds. Should you park your emergency amount in the saving account? Or should you invest it for better returns?
Keeping your emergency fund in the savings or checking account might seem sensible, but it is not the best bet. You see, the idea behind an emergency fund is not to use it right away, but should the emergency be, you must have the backup amount.
Therefore, the wisest choice is to invest the emergency amount in areas where you get at least some returns over time. However, make sure they are a safe and liquid option so that you can take your money out in the time of need.
Most experts advise parking your emergency funds into:
- Money market funds
- High-interest savings accounts
- Short-term recurring deposits
- Debt Mutual Funds
- Liquid Mutual Funds
- Overnight Mutual Funds
- A separate bank account with a suite facility
NOTE: Out of sight is out of mind. So, make sure you don’t keep the money in your savings or spending account to eliminate the temptation of spending the sum.
Redemption of Your Contingency Funds
Many liquid funds permit quick redemption of up to 90% of the deposited amount when it comes to liquidity. And, since redemption is always available you can easily credit the amount in your associated bank account.
However, make sure that the fund house permits it before investing in a liquid fund by asking for the immediate redemption option.
In this manner, by dispersing your emergency fund throughout many channels, you may guarantee speedy accessibility while reaping substantial rewards.