Rohit Banerjee had been planning a vacation to Europe with his family for last two years. He was happy that he had finally been able to save sufficient money to finance the trip to Europe. Two months before the scheduled trip, there was a minor fire in his kitchen because of which the entire kitchen was destroyed. Since Banerjee did not have enough disposable money to repair the kitchen, he had to dip into the money that he had saved for his European vacation. As a result, he was unable to take the vacation he had long been planning for.

Now, imagine if he had been investing specifically for an emergency fund for such exigencies, he could simply withdraw money from this fund instead of derailing his vacation plans. In life, there can sometimes be certain events that can have a large impact on your financial situation. An emergency fund can come to your rescue in such a situation.

What is an emergency fund?

As the name suggests, an “Emergency Fund” is an account for funds set aside for emergencies or uncertain events. It provides a buffer during exigencies and ensures no unnecessary hurdles are created in your financial journey. An ideal emergency fund should be highly liquid and easily accessible. In a way, it is like insurance. It provides you with financial protection in your time of need.

How can I build an emergency fund?

The very point of covering an emergency fund is to meet your expenses under unforeseen circumstances. Generally, it is good to have a corpus large enough to cover expenses such as monthly household expenditure, school/college fees and outstanding EMIs. Depending on your income levels and investment plan, you can create an emergency fund that will cover your expenses for a period of three months to one year.

Steps for building an emergency fund

Step I: Know your income – assess your monthly income from all sources.

Step II: Know your expense – honestly make a list of all your expenses and categorise them into discretionary and non-discretionary expenses.

Step III: Set aside money for your regular investments – it is important that creating an emergency fund should not come in the way of your financial planning.

Step IV: Create a budget – after taking the above into account, create a budget and ensure that a certain amount of money is saved monthly.

Step V: Invest this money – you can choose to apportion this investment across savings bank account, ultra short-term funds and liquid funds. These funds can offer potentially better returns than idle cash, at relatively lower levels of risk. They can also be liquidated within a span of two to seven working days.

Build an emergency fund to become your “turbulent weather” friend.