What is an Emergency Fund? Do I Need One ?
What is your first reaction when you hear the word ‘emergency’? It’s quite common that this word worries most of us. There is a certain kind of tension around this word that creeps in. We all wish to avoid emergencies. But how successful are we? Does an emergency situation tell you beforehand about its arrival? Do you think you are fully prepared to face an emergency without any hiccups? The popular answer here would be a NO.
And, did you know creating an emergency fund comes above your investment needs? Well Yes. Investments focus on wealth creation, while an emergency fund addresses sudden and unforeseen financial emergencies.
Before we move ahead to determine what an emergency fund is and if you need one or not, let’s understand what an emergency is.
What is an Emergency?
First, let’s understand what exactly an emergency is. Well, different kinds of emergencies will have a different impacts on your life. For example, layoffs, insurance co-payments, accidents, marriage separations, a pandemic, etc., are among the types of emergencies that will impact your financial position.
Then, what are not emergencies? Your annual expenses include insurance premiums, your child’s school fees, a last-minute trip to your friend’s destination wedding, cosmetic surgery for yourself, etc. These expenses do not fit into the bracket of emergency. Some of these expenses can be met by proper financial planning. While the others can be categorized as fun and recreation.
How is an Emergency Fund Different from Cash in Hand and Insurance Policy?
Were you always under the impression that your cash would take care of your emergency needs? Well, the answer might come as a surprise to you. Holding cash will lead you nowhere. Holding cash in hand is as good as losing money.
Emergencies can arise today, tomorrow, or even six months down the line. Not investing the money and keeping it idle will be heavy on your pockets. Inflation will eat into your savings, and your emergency fund may not be able to cover your emergency costs after all.
Similarly, an insurance policy is a scheme for your medical and life cover. You cannot treat it as an emergency fund. Yes, the policy will cover your costs, but not completely at times. You will have to bear certain costs yourself. Also, do not forget the co-payment clause.
Furthermore, sometimes you will have to pay the entire hospital and medical costs yourself and claim a refund with the insurance company later. Are you well financially well equipped to bear such an expense? In such scenarios, your emergency fund will act as a cushion for you to fall back on.
Therefore, never hold idle cash, and don’t consider your insurance policy an emergency fund.
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Features of an Emergency Fund
Before building an emergency fund, you should ensure that your fund is:
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Liquid: Your emergency fund’s first and foremost criteria must be liquidity. Only highly liquid funds will help you meet your costs in times of need. You should be able to liquidate your fund within minutes or in a couple of days.
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Meets Your Expenses: An emergency fund should ideally meet your emergency requirements in full or majority. To be emergency ready, you should aim to have at least six to eight months of your salary in the fund. At the same time, once you use the funds from the emergency corpus, you should replenish it without any delay.
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Not Volatile: Do not chase returns from your emergency fund. High returns require high risk, and you cannot afford to risk your emergency corpus. The emergency fund should focus on stable and guaranteed returns.
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Do I need an Emergency Fund?
Yes, without any second thought. Each one of us requires an emergency fund. Having a safety net to fall back on during unforeseen situations is a blessing in disguise. Most of us are of the opinion that ‘I’m earning enough, I don’t need an emergency fund, and my salary will take care of my needs.’ Sadly, this is not enough. Your salary might take care of your costs, but it may not take care of the hefty expenses that emergencies often demand.
Therefore, we all need to create an emergency fund for ourselves to lead a stress-free life. How much an emergency fund requires depends on your financial situation, dependent, and other factors.
Creating an emergency fund requires a thorough analysis of your earnings, expenses, and savings.
