Emergency Fund – What is it, its features and how to start an emergency fund?

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oi-Ajeeta Bhatia

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Emergencies always arise unexpectedly, but they are an inevitable part of our lives. Therefore, we must have an appropriate financial support system. Not all risks in life are insurable. You can insure your life and possibly your valuables, but some events are not covered by insurance. Insurance policies are bound by certain conditions and restrictions, leaving several emergency scenarios out of their scope. So what should a person do in dire situations where insurance is ineffective? In such a situation, an emergency fund is an important tool that can also serve as a rainy day fund. Let’s learn how to create an emergency fund.

What is an emergency fund?

An emergency fund is an essential body of money that you need to set aside to deal with life’s unexpected financial upheavals. It acts as a safety net, protecting you in the event of an unforeseen and unwanted situation. However, it should be a fund that is used only in times of crisis and not for routine expenses.

Importance of emergency funds

  • It helps in stress reduction. You tend to live a more relaxed and stress-free life when you have an emergency fund. This is because you know you have a back-up plan in case something goes wrong or an emergency arises.
  • This ensures that you will not withdraw from your future savings.
  • Your savings are tied to very important long-term goals. An emergency fund helps you reach your long-term goals by meeting your immediate needs without depleting your long-term investments.
  • This prevents you from falling into the debt trap.
  • During tough financial times, emergency funds can help you stay afloat without relying on loans or credit cards. Thus, emergency funds protect you from falling into a debt trap during a financial crisis.

How to build an emergency fund?

Set an objective-

A budget is a spending plan that helps you figure out how much money you need each month to cover necessary expenses. This figure is calculated by adding together the monthly expenses for housing, food, transportation and other necessities, then multiplying the total by six, which gives the amount needed to cover six months of expenses.

Emergency Fund - What is it, its features and how to start an emergency fund?

Make a budget-

To find ways to save, you must first understand where and how you are spending your money. Budgeting allows you to allocate your income more effectively and find ways to reduce or manage your expenses.

Increase your savings from time to time-

Increase your contribution to your emergency fund by 1% or a specific amount each month until you reach your savings goal. Increasing the amount in increments can help conceal the smaller deposit in your checking account.

Regular savings

Some emergency situations require more than a six-month safety margin. If you’ve been unemployed for more than a year or hospitalized for several months, you’ll be glad you have more money in your emergency fund.

Reduce your expenses-

Reducing the previously mentioned non-essential expenses will allow you to reach your savings goals faster and possibly even increase your monthly allowance. You don’t have to go cold turkey; just prioritize your spending. Instead of eating out every week, limit yourself to one or two outings a month, watch movies at home, limit non-discretionary online shopping, etc.

Reallocate unexpected receivables-

Did you receive a bonus at work, a tax refund or a birthday envelope from an aunt? Set aside a small amount for yourself and the rest for your emergency fund. Including any windfall wins can really help you reach your goals faster.

Article first published: Friday, November 18, 2022, 9:53 p.m. [IST]

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