Why You Need An Emergency Fund and How To Calculate It?
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Ever wondered how you may protect yourself if an outbreak crashes all your savings?
What if you lost your job tomorrow?
Would you have enough money to cover all your expenses till you find a new job?
Would you be able to pay the medical expenses for your loved ones?
We always prepare for the present but never the future and when bad things happen to us, we don’t have any backup plan and thus we fail to sustain ourselves.
That’s why I urge every millennial to start making their own budget right now. Actually, I’m forcing you to make a budget right now!
Managing your budget can be pretty difficult, especially if an unexpected emergency arises which ends up destroying all your savings.
We are all taught to earn money and to invest our money carefully, but what we aren’t taught is to create a separate reserve for when the days are not bright.
That’s when an Emergency Fund comes in handy.
Here’s exactly what an Emergency Fund is and everything you need to know about them.
What is an Emergency Fund?
Before I tell you what it is, let me tell you what it isn’t:
- It’s not used for planned purchases like a car, electronics, house, clothes, etc.
- It doesn’t have to be a big number, even a small amount set aside will suffice.
- The amount varies from person to person, you and your neighbor may not have similar expenses so your fund amount will also differ accordingly.
- It isn’t a great deal for a lovely vacation.
I think you’ve understood the don’ts of Emergency Funds. Let’s dive into what it is!
A good budget prepares you for the worst outcome and ensures you thrive successfully in your financial life.
What good budgets usually miss is a separate expense created solely for emergencies.
An emergency fund is exactly what it sounds like – A separate account created by putting aside a specific amount every month to ensure that during the financial crisis, these funds help you stay happy and don’t create problems.
It is like an insurance policy that takes care of you when needed.
Why should I have an Emergency Fund?
I mean why shouldn’t you?
It serves the purpose of paying out a huge expense that was unforeseen, which causes a massive hit to your personal life and finances. Rather than running to your friends or family for instant cash, you have a vault specifically suited for this purpose.
Maybe your mom suddenly had to be admitted to the hospital and hospital expenses being too much, you can’t afford to make regular payments.
Your employer just fired you from the job because the company has huge losses.
Your Car broke down and you need money for repairs.
Or maybe your friend needs urgent cash for an emergency he didn’t foresee.
These are a few of the problems you might face.
In such situations, having an Emergency Fund ready at your disposal proves to be of great help and Saves The Day!
Coronavirus, the pandemic we are facing now has created massive havoc among billions of people all over the world. Millions of people have been fired from their job and are currently unemployed with no savings as they never expected such a massive crisis to hit them.
The few who saved enough can survive in this situation but most people hardly save and thus are going to have massive money issues.
Having an emergency fund gives you the peace of mind of focusing on the problem at hand rather than stressing the financial aspect.
Benefits of an Emergency Fund:
- It helps you by not relying on Credit Cards for instant money.
- You have less stress as money is available at times of need.
- You don’t need to depend on your friends and family.
- You don’t have to break your fixed deposit account or your Provident Fund(PF) or Mutual Fund/Shares/Bonds, etc for money.
A lot of people turn towards their investment at such times and draw out all of their money.
Breaking your investments can hamper your earning potential. Investing is a long-term game and you shouldn’t under any circumstance break your investment and stop your money from growing on its own.
A well-funded Emergency Fund will prove to be of immense help and will ensure you don’t break your investments ever again.
How To Calculate The Amount You Need For An Emergency Fund?
Up to 6 months of your expenses.
Not so Simple answer:
Axis Bank calculator says that you should save 4-5 times your savings.
Many financial Guru’s say that 3-4 months of expenses is good enough.
David Ramsey suggests three to six months of expenses while Shark tank Billionaire Mark Cuban urges the need for a fund and says that 6 months of expenses is a correct figure.
I too suggest that 6 months of your expenses are about right to ensure that even if you are laid off, at least you can survive financially for 6-7 months which is enough time for you to find your next job.
Don’t worry, you don’t need to stock up all the money right away, start contributing small amounts initially and put some money each month towards the account.
But start Today, don’t wait for something to happen.
Sage Tip: Keep in mind that as time passes, Inflation rises and this will lead to an increase in the cost of goods, thus your emergency fund should adjust accordingly.
Where to Save your Emergency Fund?
Emergencies can knock on your doors at any time. What you need is a safe place where you can liquidate your money instantly without hassle and delay.
Thus a savings account offering good interest rates should be your go-to option.
Don’t invest this money in an FD or RD as they are term deposits which means they have a fixed duration and if money is withdrawn before the given period, you will have to pay a penalty in the form of lower interest rates.
A reputable bank that you trust and which offers normal interest rates for a savings account is optimal for you during an emergency.
How To Build Your Emergency Fund?
The simple easy 6 step process to calculate your fund amount:
- First, calculate your expenses
- Multiple your expenses by 6 [6(X) your expenses].
- Consistently put some money each month in another savings account specifically made for emergencies.
- Once you reach the calculated amount, stop pouring in more money.
- Every 6 months add some more money in your savings (just to be safer and to keep up with inflation).
- Sit back and relax as you are now Financially Secured!
How To Free Up Money To Grow Your Emergency Fund Faster?
1. Cut your expenses
Using a Budget Template, analyze all your expenses, then start prioritizing them and cut back on those expenses which seem irrelevant. You will soon notice that a bulk of your expenses are irrelevant.
Once you identify them, cut them out and you will suddenly have additional money to put in your Emergency pocket.
2. Sell things you no longer need or use
I’m telling you, you already have a lot of money in your house, just not in the form of cash.
Don’t sell everything, just those things you never use or rarely use or might be better off not using.
You can use marketplaces like OLX to sell and you can sell stuff locally. For example – I recently sold my PlayStation through OLX and got a really good amount for it. Put that money right into your account.
3. Make more money
By far the best, most popular, and awesome way is to make more money. Why is it the best? Because your income-generating potential is unlimited.
You could simply start freelancing online, or work part-time for another company or start a side business not just to make extra money to put aside for your Emergency Fund but also to increase your monthly earnings which in turn increases your investments.
Once you speed your way using the three tips and feel you have saved enough for all your expenses, you can create another account for another expense you feel has importance and needs control.
I would create a Vacation account that will be solely used for traveling. A vacation for myself that each year that I won’t regret sounds exciting, doesn’t it?
This helps you not only to be organized but also to ensure you do not overspend on vacations as you have a limited budget. This is also a great way to ensure you travel at least once every year.
Similarly make separate accounts for all your various needs.
What To Do Once You Empty The Account?
Refill it. Yeah, it’s that simple. If at any time you use your emergency fund, you need to start refilling the money as soon as you can. But this time if possible, try to put in the calculated amount plus a bit extra (like 10% more).
Don’t pressurize yourself, maintaining the initial amount works just fine. But not maintaining an emergency fund at all is not Fine.
The Next Step?
Creating an emergency fund is just the beginning of your successful financial journey. Once you get a good grip of it, your next targets should be:
- Pay off any debts.
- Open a retirement account.
- Invest excess money.
- Spend on luxuries (don’t be a miser, enjoy your life).
- Donate money to people who need it the most.
Should You Spend Your Emergency Fund Money?
Sometimes, you might feel like using some of your fund money, but you shouldn’t.
You’ve got to believe that it doesn’t exist and make financial decisions accordingly.
Think of your Fund as an insurance policy, which you need at the worst hour. At an hour where no one could help you, your Emergency Fund comes to the rescue.
If many years pass by and you never use your fund, don’t get angry that your money is wasted, rather be grateful that a storm never hit you and your family.
Everyone needs to save money for the inevitable crisis. Don’t be the person who suffers once the crisis hits. Be Prepared.
Having a backup plan is a lifesaver and extremely crucial for your well-being and the well-being of your family.
Let’s not Be Scared but Be Prepared.
So tell me, do you have an Emergency Fund? What other funds do you maintain? Let me know down in the comments.
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