A financial emergency can have a devastating impact on your life. Without adequate prep, such an event can lead to a heavy loss of wealth and investments, spoil your credit score, and leave you ill-equipped to achieve crucial financial goals. An adequate emergency fund is an effective tool that can cushion your finances against the impact of a financial crisis. While an emergency fund is essential, managing it well is equally important.
Here are some tips you can consider to manage your emergency fund efficiently.
Build an adequate contingency fund
An adequate contingency fund should help you sustain day-to-day expenses for at least 6-12 months. Such expenses include food, rent, EMIs, children’s school fees, fuel, and utility bills. The impact of a financial emergency can be significantly reduced with an adequate contingency fund.
If you have started a contingency fund, review it regularly and adjust it to your changing lifestyle and spending habits. For example, the contingency fund requirements of an unmarried person who has recently joined the workforce will differ from those of a person who is married, working at a mid-level position, and has a debt to repay.
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Keep it invested in an accessible instrument
Invest your contingency fund in an instrument that offers modest returns and easy liquidity. Bank fixed deposits, liquid funds, and high-interest-paying savings accounts are some examples of instruments which offer both these benefits. While easy liquidity will ensure quick access to the fund in times of need, the returns will help beat inflation and allow your fund to grow with time.
You may also adjust the quantum of your contingency fund based on your changing financial obligations. For instance, if you have taken a loan, increase your contingency fund accordingly to cover loan repayments. Once you have repaid the loan, decrease the size of the fund. Avoid parking your contingency fund in instruments which don’t offer easy liquidity or have a lock-in requirement.
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Know when to use your emergency fund
In the event of an emergency, treat your emergency fund as a last resort. Use it only when you don’t have the means to cover day-to-day financial needs, such as purchasing groceries, paying the electricity bill, repaying debts, etc. Don’t treat your emergency fund as a permanent solution. It is a temporary financial arrangement which must only be used to overcome financial distress. Prioritise essential expenses when calculating the quantum of your contingency fund, and stick to using it only for them.
You may maintain separate emergency funds for family needs, health emergencies, personal expenses, to repay loans, etc. Remember that the cumulative fund should be sufficient to cover your financial expenses for at least 6-12 months. Also, inform your immediate family – spouse, parents, etc., about the fund so they may access it in your absence if the need arises.
After all, the resounding lesson the last few years have taught us is that emergencies often strike with little warning. Being adequately prepared for them is what you can do to safeguard yourself and your loved ones.
(The author is CEO, Bankbazaar.com)