How to Build Your Emergency Funds?

Life is filled with uncertainties, and unexpected challenges can arise at any moment. Whether it’s a sudden job loss, a medical emergency, or unforeseen repairs, having a safety net in place can make all the difference. Enter the emergency fund – a vital financial cushion that offers peace of mind and helps navigate the stormy seas of life with confidence.

In this blog, we will explore the question that plagues the minds of many responsible savers: “How to build an emergency fund?” While there’s no one-size-fits-all answer, understanding the factors that influence the ideal amount can help you tailor your approach to building this essential financial reserve.

What Are Emergency Funds?

Emergency funds are savings set aside to cover unexpected expenses or financial emergencies, such as medical bills, car repairs, or job loss. They provide a financial safety net and help avoid the need to rely on credit cards or loans during difficult times. Ideally, an emergency fund should cover three to six months’ worth of living expenses, allowing you to manage financial challenges without disrupting your long-term financial goals.

What Is the Importance of Emergency Funds?

• Financial Stability: They provide a safety net during unexpected financial crises, helping you avoid debt and maintain stability.
• Peace of Mind: Knowing you have funds to cover emergencies reduces stress and anxiety about financial uncertainties.
• Avoiding High-Interest Debt: They prevent the need to rely on high-interest credit cards or loans when emergencies arise.
• Flexibility: Having an emergency fund allows you to manage expenses without disrupting your regular budget or long-term savings goals.
• Security: It ensures you can handle sudden expenses, such as medical bills or car repairs, without impacting your overall financial health.

How to Build Emergency Fund?

Building an emergency fund involves several key steps:

1. Set a Goal: Determine how much you need based on your monthly expenses, aiming for 3 to 6 months’ worth of living costs.
2. Create a Budget: Analyze your income and expenses to identify how much you can set aside each month for your emergency fund.
3. Open a Separate Account: Keep your emergency fund in a separate savings account to avoid the temptation of spending it on non-emergencies.
4. Automate Savings: Set up automatic transfers from your checking account to your emergency fund each month to ensure consistent contributions.
5. Cut Non-Essential Expenses: Reduce spending on non-essential items and redirect those savings to your emergency fund.
6. Increase Savings Over Time: As your financial situation improves, increase your contributions to build a larger safety net.
7. Use Windfalls: Deposit any unexpected income, such as bonuses or tax refunds, into your emergency fund to boost its balance more quickly.

How Much Do You Need to Put in Emergency Fund?

The amount you should put into your emergency fund each month can vary greatly based on your personal financial situation and expenses. However, a common rule of thumb is to aim for building an emergency fund that could cover 3-6 months’ worth of living expenses.

Let’s assume:

• Your monthly expenses amount to ₹40,000.
• Your goal is to have a six-month emergency fund, which equals ₹40,000 x 6 = ₹2,40,000.
• You already have ₹20,000 saved in your emergency fund.

To reach your target of ₹2,40,000:

• Subtract your existing savings from the target: ₹2,40,000 – ₹20,000 = ₹2,20,000.
• Divide the remaining amount you need to save by the number of months: ₹2,20,000 / 12 = ₹18,333.

So, in this example, you should aim to save ₹18,333 every month to reach a total emergency fund of ₹2,40,000 within a year. Adjust these calculations based on your own expenses and financial goals.

One important thing to remember while calculating your monthly expenses is to consider EMIs and insurance premiums that need to be paid.

This can feel like a huge number, especially if you’re starting from scratch, but it is not really that difficult to put together. The important thing is to start putting some money aside every month.

How Long Does It Take to Build an Emergency Fund?

The time required to create an emergency fund depends on several factors, including the target amount, monthly savings rate, and starting balance. Here’s a breakdown:

1. Target Amount:
   • Example: If you aim to build an emergency fund of ₹2,40,000 (covering six months of ₹40,000 monthly expenses), the time needed will depend on how much you save each month.

2. Monthly Savings Rate:
   • Example 1: Saving ₹10,000 per month will take approximately 24 months (₹2,40,000 ÷ ₹10,000 = 24 months) to reach your goal.
   • Example 2: Saving ₹5,000 per month will take around 48 months (₹2,40,000 ÷ ₹5,000 = 48 months) to achieve the same amount.

3. Starting Balance:
   • Example: If you already have ₹20,000 saved, you only need to accumulate ₹2,20,000 more.
     • Saving ₹10,000 monthly would reduce the time to 22 months (₹2,20,000 ÷ ₹10,000 = 22 months).
     • Saving ₹5,000 monthly would take 44 months (₹2,20,000 ÷ ₹5,000 = 44 months).

How to Secure Emergency Funds?

Securing your emergency fund is crucial for ensuring that it remains accessible and safe. Here are key strategies:

Choose the Right Account:

• Savings Accounts: Opt for a high-interest savings account with easy access and no penalties for withdrawals. Some banks offer specific high-yield savings accounts for emergency funds.
• Fixed Deposits: Consider short-term fixed deposits with a flexible tenure to earn higher interest while keeping the funds relatively accessible.

Invest in Liquid Assets:

• Liquid Mutual Funds: These funds offer higher returns compared to traditional savings accounts and provide easy access to your money. They are designed for short-term investments with high liquidity.
• Government Securities: Invest in instruments like Sovereign Gold Bonds or Treasury Bills, which are low-risk and backed by the government.

Diversify Your Savings:

• Bank Deposits and Bonds: Spread your emergency funds across various financial instruments to minimize risk. This includes a mix of savings accounts, fixed deposits, and government bonds.

Avoid Risky Investments:

• Avoid Stocks: For emergency funds, steer clear of volatile investments like stocks, which can be unpredictable and may not provide immediate liquidity when needed.

Regularly Review and Adjust:

• Periodic Check-ups: Regularly review your emergency fund allocation to ensure it aligns with your current financial situation and goals.
• Inflation Considerations: Adjust your fund to keep up with inflation and changing financial needs.

When Should You Use Your Emergency Fund?

You should use your emergency fund in the following situations:

1. Medical Emergencies: If you or a family member faces unexpected medical expenses that are not covered by insurance, your emergency fund can help cover these costs.
2. Job Loss: If you lose your job or face a temporary reduction in income, your emergency fund can provide financial support while you search for new employment or navigate through the period of reduced income.
3. Major Home Repairs: For urgent repairs or maintenance of your home that cannot be postponed, such as fixing a broken water heater or a leaking roof, your emergency fund can cover these unexpected expenses.
4. Vehicle Repairs: If your car breaks down or requires significant repairs that are essential for your daily commute, your emergency fund can help cover these costs without disrupting your regular budget.
5. Unexpected Expenses: Any unforeseen expenses, such as a sudden family event or an urgent personal matter, can be managed using your emergency fund to avoid financial strain.

Example: If you face an unexpected medical bill of ₹20,000 that you didn’t anticipate, using your emergency fund can help you pay for it without having to borrow money or disrupt your regular financial plans.

Things to Consider When Building an Emergency Fund

The amount you should save in your emergency fund depends on your personal financial situation, including your income and expenses. While there’s no universal rule, here are some helpful guidelines:

• Expenses: A common recommendation is to save enough to cover three to six months of living expenses. Calculate your monthly essential expenses—such as rent/mortgage, utilities, groceries, insurance, and transportation—then multiply that by the number of months you want to cover.
• Earnings: Base your savings on your income. If you have a steady monthly income, try to set aside a portion each month until you reach your target. If your income varies, aim to save a fixed percentage or amount from each paycheck.
• Risk Tolerance: Your job stability and personal circumstances also play a role. If you have a stable job and low-risk lifestyle, a smaller emergency fund may suffice. If your income is less stable or you have dependents, you may need a larger fund.
• Existing Savings and Debt: Consider your current savings and debts. If you have high-interest debts, focus on paying those off first before fully funding your emergency fund. If you have some savings, allocate part of it to your emergency fund and build from there.
• Cost of Living and Commitments: Your cost of living and financial commitments vary based on where you live and your lifestyle. Factor in your rent/mortgage, loan payments, and other fixed expenses to determine the right size for your emergency fund.

Bonus Points: Build Your Emergency Fund with Ease

Struggling to start building your emergency fund? There’s a simple and effective way to do it: invest through Paytm’s Daily SIP. With this feature, you can start with as little as ₹21, ₹51, or ₹101—whatever suits your budget. The amount you choose will be automatically deducted from your linked bank account daily, making it an effortless way to grow your savings. This approach not only makes saving manageable but also helps you steadily build a solid financial cushion for the future. And the best part? Your daily SIP is invested in mutual funds, so you earn interest on your contributions, further enhancing your savings.

Example: If you choose to invest ₹51 daily, by the end of the month, you will have contributed ₹1,530. Over a year, this would accumulate to ₹18,615, not including the interest earned from the mutual funds. This approach makes it easier to build a substantial emergency fund while taking advantage of investment growth.

Can Inflation Impact an Emergency Fund?

Yes, inflation can impact your emergency fund by reducing its purchasing power over time. As the cost of goods and services rises, the amount you’ve saved might not stretch as far as it once would have, making it harder to cover unexpected expenses. To mitigate this effect:

1. Adjust Your Savings Regularly: Periodically review and increase your emergency fund contributions to keep pace with inflation and ensure your fund maintains its value.
2. Invest Wisely: Consider placing a portion of your emergency fund in a high-yield savings account or low-risk investment options like liquid mutual funds that offer better returns while still providing easy access.
3. Diversify Your Savings: Spread your emergency fund across various financial instruments, including government bonds or fixed deposits, to safeguard against inflation’s impact.
4. Monitor Inflation Rates: Stay informed about current inflation rates and adjust your financial planning accordingly, ensuring your emergency fund remains sufficient for your needs.