Why you need an Emergency Saving Fund?
One of the main objectives of a good financial planning is preparing for the future, whatever it may bring. Therefore, an essential component of a solid financial plan is an emergency fund. An emergency fund is designed to cover a financial shortfall when an unexpected expense crops up. Your emergency fund can serve as a place to get the money you need when you find yourself short. Because it must be reliable, it needs to hold guaranteed investments. In other words, savings accounts are good for emergency funds, while stocks are bad. An emergency fund, by nature, also needs to hold liquid or otherwise short-term, accessible investments with complete safety.
Starting an emergency savings fund is one of the important things in your personal finance. One of the main aspects in your financial planning is allocating a certain percentage of your savings for the emergency purposes. Many personal finance experts agree that this is one of the first things you should do, ranking ahead of paying off high interest debt. This article will cover why you need emergency savings, how much you need, and where to put it.
Why Save for Emergencies?
There are a number of situations that arise in life that you simply do not have control over. Should these situations require immediate cash flow, it is essential to have emergency savings to cover it. If you have a personal investing account or retirement account you could pull funds from these, but for a number of reasons including bad market timing, early withdrawal penalties, or a delay in the liquidity of actually selling your investment and receiving your funds, this is the last thing you want to do. Having money set aside for emergencies not only prevents this from happening, but also gives you the peace of mind that if something unfortunate was to happen that you will have a little financial cushioning to ride it out.
What Types of Situations May Require Emergency Savings?
I'm sure that you have needed fast cash for a number of situations in your life, or seen situations where others have. Insurance may cover many of these scenarios for you, but there is always a chance that it won't cover fully what you will need. Here are a few examples:
a) lost job or layoff
b) began a new job that required you to expense a geographic move
c) auto accident, or major auto repair
d) Major home expense such as a broken water line, fire, natural disaster effects, etc.(if not covered by insurance)
e) death in family that required you to help the family
f) unexpected medical expenses not fully covered by insurance
Basically you need to create two types of emergency funds
- Your short-term emergency fund is your go-to place when you have an immediate emergency. It should be in an accessible account, which will probably bear little interest. The most important consideration is accessibility. You'll want a debit card attached to this account and check-writing privileges as well. The purpose of your short-term emergency fund is for smaller emergencies, such as car repairs or replacing a major appliance that has broken. It can also be used as a bridge to get you through the few days until you can access your long-term emergency funds in case of a more extreme situation.
- A long-term emergency fund allows you to save for large-scale emergencies, such as job loss or a major natural disaster like an earthquake or fire, and earn a slightly higher level of interest. Accessibility is still important here, but it's okay to choose investments that take a few days to liquidate – as long as you have a short-term emergency fund to cover you in the interim.
When you have an emergency fund, you have peace of mind. Your money is on guard, so to speak, just waiting to be called into action. You don't have to scramble to come up with money you need and you don't have to turn to credit cards. Even if your emergency fund isn't big enough to handle everything, it can still help reduce the amount of money you must look for from friends and family, or credit cards.
How Much Should you Put in Emergency Savings?
This is where the experts tend to differ. There are a wide range of guidelines out there for how much you should save. Pick one or a combination, but ultimately, you have to choose an amount that you're comfortable with and that feels right for you. Here are some of the general guidelines out there:
A) 3-6 months worth of take home salary
B) 6 months worth of living expenses
C) Start small and pay off debt before building 3 to 6 months worth of living expenses
I think it is wise to earmark 2-3 months' salary for emergency purposes (this varies persons to person depending on their earnings). Start Focus on paying off high interest debt, paying all of those off first before adding to your emergency savings is not a good idea. Here's where the twist comes in – if you are anticipating a major life changing event coming up, add to your fund or simply another savings account. You do not want to be pulling from emergency funds to pay off anticipated expenses.
Where should you put your Emergency Savings?
You should be earning interest from your savings, otherwise, you are losing value due to the effects of inflation. Place your emergency fund into a high interest savings account, Liquid Fund Account, or money market mutual fund schemes. Stay away from Bank Fixed Deposits because if you pull your money out prior to the FD maturity date, you will lose interest in the form of a penalty. Bank SWEEP-IN deposit is another alternative.
Go with a bank that offers quick and easy access to your fund and a competitive rate. Always open bank accounts with reputed bank providing good services and modern technologically advanced facilities like online banking, ATMs etc. Use this as a starting point to see what the current savings bank rate is before committing. Check back periodically to see if you're getting the best going rate (because recently RBI deregulated the savings bank rates, so the banks can change the SB account interest rates at any time at their description) . If you're not, don't be afraid to switch. If you haven't already, start building your emergency savings. It will help you sleep better at night.
Conclusion
An emergency fund can mean the difference between financial failure and financial success. Not only must you develop discipline to accumulate one, but an emergency fund will prepare you for unexpected setbacks and reduce your dependence on borrowing money, most likely at high interest rates.
Carefully examine your expenses and use the information to develop an emergency fund goal, see how much you can save each month, and identify unnecessary expenses, or wasted money. Make a plan to build up an emergency fund and decide how you want it allocated. Finally, use your emergency money wisely.
Best Regards
Prakash Nair
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