Emergency Fund 101: Why Do You Need Savings For Unexpected Expenses | How To Build an Emergency Fund

Before we talk about emergency funds, a question comes to our mind, "What is an emergency?" Simply speaking, it's a serious event which requires immediate action. But how is this related to personal finance?

To understand this, let's take an example.
Suppose you have a small family of 3 members, and you're the sole bread earner. Unfortunately under some unavoidable circumstances, you lose your job, and at the same time, your only child falls seriously ill. What would you do? How will you act?

Well, your approach will depend on your savings. If you have enough savings, you will quickly admit your child in a good hospital. If you have no savings, you'll look for a lender, which will cost you time (which is very crucial in case of emergency), and then you'll take a loan at a high interest rate.

So in the above example, you have seen the effect of emergencies on our finances. The scenario in which you have savings, you save time and act quickly in an emergency, but in the scenario in which you have no savings, you lose time and didn't act quickly, and took a loan of high interest, repaying which is now a great burden, as you have no job.
So now you also understand the importance of savings in times of emergency.


What is an emergency fund?

An emergency fund is a cash reserve that is kept un-invested, for any future unplanned expenses or emergencies.
It's very important to have an emergency fund, as:

1. It saves your time and allows you to act quickly.

2. It prevents you from taking high interest loans.

3. It protects your financial stability in case of an emergency.

4. It keeps you stress free, as you've already planned for future emergencies.

5. It allows you to take risks, like changing jobs, business, shifting to a new place, etc, without stressing about the sudden rise of unexpected expenses.


How to build an emergency fund?

Before thinking about how to build an emergency fund, first ask yourself one simple question: "How much do I need?"

To figure it out, first list all your expenses, and also the past unexpected expenses. Now add all your necessary monthly expenses, suppose you get an amount equal to X. Then necessary expenses for two months will be 2X (useful in case you lose your job).
Now add all unexpected expenses of the past 6 months, suppose you get an amount equal to Y.
Now make an estimate of primary expenses on medical treatment of your family (in case of any emergency), suppose you get an amount equal to Z.

So minimum emergency fund, which you need to have = 2X + Y + Z

Now how will you build this emergency fund? Don't worry. Just follow the following strategies:

1. Create a savings habit.
Set a goal, and create your monthly budget in such a way, that it allows you to reduce your expenses and save more.

2. Manage your cash flow.
Record and keep track of all your cash flow. Mention the date you got your salary, mention each and every expense, mention the date you paid your rent, credits and bills, mention the date you run out of cash. Do this regularly, and you'll have an overall idea about how to minimise your expenses in a smart way, and save more.

3. Take advantage of one-time opportunities to save.
One-time opportunities means, a sudden extra money which you get. It can be your festival bonus, tax returns, gifts, etc. You should not spend them. Instead, save them to build an emergency fund.

4. Make your savings automatic.
Set up recurring transfers from your bank into a Recurring Deposit (RD), which will give you a better interest and will help you in times of emergency.


By following these strategies, you'll be able to build your emergency fund, and make yourself future ready.

For more such tips on personal finance and investment, keep visiting this blog!