How to plan your emergency fund?
The ongoing pandemic has definitely made us realise the importance of various personal financial aspects and emergency fund is one of them. In life, nothing is going to happen as per your plan even if we intimate you in advance. So, in such cases, being prepared well before any situation arises is a wise thing to do. COVID-19 along with other problems has created financial crisis as well. As a result, many investors, specifically the equity investors, suffered huge losses. On the top of that, we are also seeing that many companies are on the verge of job and salary cuts. In such a situation, surviving peacefully is quite difficult. Therefore, in order to sustain such a crisis and have a peace of mind, you need to plan your finances accordingly. Amidst this, emergency fund planning becomes one of the most crucial aspects to look at.
What is an emergency fund?
Emergency fund, also known as contingency fund, is a corpus created to take care of financial emergencies arising in the short-term period. The emergencies can be in the form of medical emergency or payment of dues or even a temporary loss in income. Therefore, having an emergency fund in place often helps you to take care of such emergencies without panicking. However, now you may ask how to build an emergency fund? Don’t worry! In this article, we will help you to understand the process of building an emergency fund.
How to build an emergency fund?
Building an emergency fund requires a few inputs such as your fixed expenses, outgo in the form of insurance premium and EMIs. Hence, we would recommend you to first note down all the fixed expenses, i.e. those which cannot be avoided under any circumstances. For instance, payment of rent, electricity bill, cooking gas, groceries, school fees, doctor fees, medicines, etc. are all fixed expenses which even if you lose your income, you can incur it for your survival. On the contrary, expenses such as dining out, buying clothes, buying gadgets, going for a movie, etc. are examples of discretionary expenses and are not necessary for your survival.
Hence, first understand what your fixed expenses are. Also, along with fixed expenses, note down your insurance premium and EMIs. Let us take an example, which will help you to calculate the required emergency corpus. Suppose your monthly fixed expense is Rs 30,000, your annual insurance premium is Rs 25,000 and your EMI is Rs 20,000 per month. Now with this, we would calculate an emergency corpus, which will account for your six months expenses.
|
Outflow
|
Amount (Rs)
|
|
Fixed Expenses
|
30,000
|
|
Insurance Premium
|
25,000
|
|
EMI
|
20,000
|
|
Emergency Corpus
|
3,25,000
|
Now, you might be wondering that how come the emergency corpus is Rs 3.25 lakh. As annual expenses are Rs 6.25 lakh and dividing it by two, makes Rs 3.12 lakh. So, ideally as per this calculation, it should be Rs 3.12 lakh. But we need to understand that we usually pay the insurance premium annually. Hence, we need to consider it as a whole and as we incur fixed expenses and pay EMI every month, we can take it for six months. Hence, the corpus required would be Rs 3.25 lakh.
How much should an emergency fund be?
As a thumb rule, you should have a minimum of three months to six months of your expenses as an emergency fund. However, it is bare minimum. So, we would recommend you to have minimum of one year of expenses as your emergency corpus. Definitely the amount required would be on higher end but you can consider building it gradually. Not just that but you even need to review it annually to account for the change in your spending patterns.