AN emergency fund is meant to meet non-recurring expenditures like sudden loss of employment, illness, or an accident. Keep the following things in mind while building an emergency fund.
Size of the fund
Save to cover living expenses for at least six months. That should take care of fixed expenses like EMIs, rent, tuition fees, utilities, supplies, and insurance premiums. Do not include the cost of lifestyle choices – clothes, eating out, gadgets, holidays,— those options are best avoided during a financial crunch. To build this fund, set aside a percentage of monthly salary: a minimum of 5% or more if you are so inclined.
Where to keep the money
While an emergency requires liquidity, loose cash will earn you no interest or capital growth. You could lock your emergency fund in a fixed deposit or a high interest rate savings account. A recurring deposit that automatically debits your account with the decided monthly sum is a good way to start. Deposits also provide instant liquidity and full safety of capital when investing with reputed banks. If you’re feeling adventurous, you could also build this fund over a long period through equity mutual fund SIPs.
Keep topping up the fund
Your income may grow over the years but inflation keeps increasing your monthly expenses too. Therefore, even if you’ve met your fund target, it is necessary to keep reassessing your emergency fund size so that it matches your most current requirements. Your emergency fund when you’re single and 25 years old would be smaller than when you are 35 and have a family to support. Topping up is especially important if you’ve already dipped into your emergency fund. Interest growth can provide you 7-8% before TDS, therefore you can aim for top-up of 5-10% of the fund size to keep it growing faster than the rate of inflation. Once you have prepared for emergencies, you would have little need for loans or borrowing from friends. You would not have to deal with the stress of not knowing how to tackle an emergency.
The writer is CEO of BankBazaar.com