Importance of emergency fund planning

When it comes to financial planning after streamlining the cashflows, the very next step is to plan for contingencies. Planning for emergencies often helps to overcome the cash crunch at the time of income loss. There is a valid reason to have an emergency fund in the first place. This is because when there is a loss of income, there are various mandatory expenses that you need to incur which also includes your EMIs. Having an emergency fund in place help you to keep safe the investments that you have made towards your financial needs such as child’s education, retirement, etc.

How to build an emergency fund?
It is not just important to know that you need and emergency fund. It is equally important to know how much you need it and how to build it. Now let’s first understand how to know how much you need. The emergency fund should include all the fixed expenses which are mandatory on your part. Expenses such as rent, groceries, school fees, etc. which are mandatory in nature must be included in emergency fund calculation. On top of that, you also need to include the insurance premiums that you pay and EMIs.

Now you need to know how many months of expenses you need to keep as an emergency fund. This usually depends on the occupation that you are into. Why occupation? because every occupation has different levels of job security. For instance, if you are a government employee then the job security is high and you may only need to keep 3 months of your expenses in an emergency fund. However, if you are someone in a sales job where there are high chances of job loss then you need to have as high as 9 months of expenses in an emergency fund. So, once you have decided with the number of months of expenses to keep as an emergency fund, the next step is to first add the fixed expenses and EMIs then multiply by the number of months. Post this, add the insurance premiums to the resultant amount. The reason behind adding the insurance premiums later is that insurance premiums are usually paid annually.

Now as you have calculated the amount required for an emergency fund, its time to build it. Let us assume that you have to keep 6 months of your expenses in an emergency fund. Of that, it is prudent to keep 1 month of expenses in a savings bank account, 15 days of expenses as cash at home and remaining to be parked equally in liquid funds and ultra-short duration funds. You may be wondering as to why to keep 15 days of expenses in cash. The reason behind the same is that if in the time of emergency, you are not able to access the ATM then you should have enough cash to bear the daily expenses until the ATM becomes accessible. This issue may arise due to flood-like conditions where ATM is not assessable for many to withdraw cash. At such times having cash helps you to fulfill your daily needs.