Difficult situations test our physical, mental, and emotional resilience, and it is difficult to be prepared for these beforehand. But one thing that we can surely work on to ease our way through adversities is strengthening our financial standing. Being financially sound can be of great help in navigating life's challenges more effectively. Hence, financial planning is important to guarantee a stable future for oneself and one's loved ones.
What is an emergency fund?
An emergency fund is a sum of money set aside to help through unforeseen situations in life. In the absence of an emergency fund, such a situation would require you to dip into your savings and investments, if any, or else resort to taking loans. Redeeming investments can impact your long-term financial planning, and loans are a worse option as they can lead to a debt trap. Hence, it is important to be financially prepared for exigencies by having an emergency fund.
Why have an emergency fund?
In essence, an emergency fund provides support in the event of unanticipated events for which you may not be covered by insurance or for which it may not be applicable. For instance, losing your job suddenly, business incurring losses or shutting down, experiencing a medical condition that is not covered by your health insurance, etc. An emergency fund serves as a safety net in these situations, relieving you of unnecessary worry and tension and saving you from the debt trap.
How to build and maintain an emergency fund?
1. Determine: The first step in setting up an emergency fund is to determine the amount you should have in the fund. A minimum amount equal to 6 months of your family income is a good starting point. You can later build on this basis your income, expenses, number of dependents, etc.
2. Plan: Park the emergency funds in a low-risk investment that not only keeps your money safe but can also be easily liquidated when required. A savings bank account is a good option for the purpose. It is advisable to have a separate account for your emergency fund to avoid using the money for regular expenses. Having a joint account with your spouse or other family member will ensure that that in an emergency, another family member can access the funds. To reach the minimum target amount in the fund, you can start with a lump-sum contribution if possible or plan to set aside a fixed amount from your monthly income. The idea is to reach the goal at the earliest and then slow down to a steady pace.
3. Action: To guarantee regular and constant contributions to the emergency fund, set up an automated monthly transfer. Reduce your spending on things you do not need, then use the money you save and any additional inflow of money to boost your fund contributions until you meet the minimum target amount.
4. Build: After you have reached the minimum goal, you must keep going. However, you can ease into a steady pace by choosing a regular contribution amount and setting up auto-transfer to help the money grow. It is important that you strictly use the fund only in case of an emergency and not dip into it when falling short for some regular or wishful expense. The resolve to keep the emergency fund sacrosanct is crucial to ensure that the fund serves its intended purpose when required.
5.. Maintain: It is critical to monitor your emergency fund to make sure it can cover your needs in an emergency, which can vary depending on your life stage. For instance, you would need to reevaluate the amount in your emergency fund as your children pursue higher education and your parents’ age. Ideally, there should not be any reason to be concerned if you have been regular with your contributions and have made sure to replenish the fund each time you have taken money out of the account.
An emergency fund serves as a back-up source of funding in times of financial need that can challenge your best-made plans. Having an emergency fund can save you from mental stress and from getting looped in high-interest debt. It also gives you time to plan your finances and make necessary arrangements for the unexpected expense. However, it is very essential to have insurance to stay financially secure in the face of life’s contingencies. Life insurance, health insurance, disability insurance, child plans, retirement plans, general insurance plans to safeguard key assets, etc. are investments that should necessarily be considered for sound financial planning.
