The ongoing Covid-19 pandemic may be far from over, but it has reaffirmed our belief in having an emergency fund. I have repeatedly emphasised the utmost importance of an emergency fund as part of financial planning in many articles. Its significance was reinforced by BankBazaar’s 2020 Saving Quotient data which highlighted that although savings have shrunk for people due to the ongoing economic challenges, they have been proactive in accumulating fund to deal with uncertainties. As per the data, emergency savings have become the biggest reason for saving for 70% people versus 32% in 2019.
Therefore, it is important to have an adequate emergency fund to help us deal with rainy days and it should be an integral part of financial planning.
Why An Emergency Fund Is Important?
An emergency fund is that pot of money which you create for unpredictable financial events. It is a buffer derived out of your income to deal with your regular expenses if a job loss kind of emergency strikes. It is a fund to help you lead a dignified life even if your regular income is disrupted. While there is no defined size for an emergency fund, it should be adequate to meet your regular expenses for 6-12 months, or more if required. Also, your emergency fund should be parked in easily accessible financial instruments.
Important Question To Ask Before Using Your Emergency Fund
The idea to have an adequate emergency fund in your financial portfolio rests on the fact that unpredictable events can happen and you should be financially prepared to deal with them. However, it should not be seen as a fund that you can easily access to meet your regular expenses. The purpose of this fund is to rescue you during exigencies. So you have to dip into this fund only when there is a financial emergency which your income can’t support. To assess if a situation merits for the emergency fund use, you can ask yourself these important questions.
Is The Need Sudden?
Events like a sudden job loss or medical emergencies create financial challenges. Liquid money is needed at very short notice and one is left with no choice but to either borrow or liquidate their investments. The big dilemma is which of these is more beneficial and less stressful. The emergency fund you are building is meant to be your support for such situations. So assess if there has been a loss of income due to a job cut, or there is an emergency due to a loved one’s unfortunate demise or medical need to look up to your emergency fund. You might be tempted to use it for regular expenses or any other discretionary spend but if it doesn’t fit in your unexpected need, it is not to be touched.
Are You Using The Emergency Fund To Address Your Want Or Need?
Before you use the emergency fund, understand the difference between wants and needs. While want is something that can be controlled, needs cannot be ignored. For instance, you aspire to have a new car when you already have a vehicle that suffices your needs. Now, using the emergency fund to sponsor this luxury car is a want that you can easily ignore or fulfil by working on a separate fund for this. On the other hand, you can use an emergency fund if there is a sudden hospitalisation and the expenses have stretched beyond your health insurance cover.
Is There Any Other Way You Can Deal With The Situation?
It takes a lot of hard work and time to accumulate an emergency fund. When an emergency strikes, you must review your financial portfolio. Check each of your accounts and the amount you can spare to deal with important expenses. As a first step, explore all your options before reaching out to your emergency fund. If any payment or expenses can be delayed till you get a new job or your regular income restores, try doing that. But try to avoid borrowing as the main idea behind an emergency fund is to protect you in times of crisis.
Before touching your emergency fund, assess your situation based on the above-discussed questions to make a prudent move. If you have used your emergency fund, try to replenish it as soon as possible as you cannot afford to stay long without it. While creating an emergency fund, build it smartly by saving the money in investment instruments that can help your money grow and provide easy liquidity too. A recurring deposit or fixed deposit is a great way to build an emergency fund. Your emergency fund should be separate from your regular savings and should be maintained regularly with any compromise.
The author is CEO, BankBazaar.com, India’s leading online marketplace for loans and credit cards.