Summary of this article
A job loss or medical emergency can strain your finances. Having three to six months' expenses saved can help you tide over the crisis.
Freelancers, self-employed professionals and single-income households may need a bigger emergency fund to manage uncertain cash flows.
Don't wait for an emergency to start saving. Build a financial cushion gradually so you don't have to disturb your long-term investments when a crisis strikes.
A job loss, a medical emergency or an expensive repair at home can upset a family's finances overnight. Even people who manage their money carefully may find themselves dipping into investments, breaking fixed deposits (FDs) or taking a loan to meet an unexpected expense. Having some money set aside for such situations can make a difficult time a little easier.
So, how much should you keep aside? A good starting point is three to six months of household expenses. But this is not a fixed rule. “If your income is irregular or you have several financial responsibilities, you may need a larger amount,” say financial experts.
Work Out Your Monthly Needs
Before deciding on how much money to keep in an emergency fund, look at your monthly household budget. How much goes towards the home loan EMI or rent, groceries, electricity bills, school fees, insurance premiums, medicines and travel? Add up these expenses first. These are the payments you will have to continue making even if your income stops.
For example, if your essential monthly expenses work out to Rs 60,000, you should aim to have Rs 3.6 lakh for six months. If you want a cushion for nine months, the target will be Rs 5.4 lakh.
There is no need to include expenses such as eating out, shopping or holidays in this calculation. These can be cut back if money becomes tight. The focus should be on how much your family needs to get through the month without making major changes to its lifestyle.
There Is No One-Size-Fits-All Number
A salaried person with a regular income and a working spouse may be able to manage with a smaller reserve than someone who runs a business or works as a freelancer. The latter may have to deal with months when payments are delayed or work is hard to find.
For someone with a reasonably secure job, three to six months of expenses may be sufficient. Those who are self-employed, work on contracts or have uncertain earnings should look at keeping nine to 12 months' expenses aside.
Family circumstances also make a difference. If you are the only earning member, have children or dependent parents, or are paying a sizeable home loan EMI, it makes sense to keep a larger amount. You do not want a temporary loss of income to force you into selling investments or missing loan payments.
Where Should You Park The Money?
There is little point in building an emergency fund if you cannot get your hands on the money when you need it. Keep a part of it in your savings account so that you can withdraw cash immediately. The rest can be placed in sweep-in FDs or short-term bank deposits that allow premature withdrawal.
Liquid mutual funds are another option for a portion of the money, but they are not the same as a bank deposit. Returns are not guaranteed, and redemption is subject to processing time. Avoid putting your emergency savings in stocks or equity mutual funds. If you need the money when markets are falling, you may have to sell at a loss.
Keep Reviewing The Amount
An emergency fund that was adequate a couple of years ago may not be enough today. Household expenses go up, children move to higher classes, medical costs rise, and loan commitments change. Take another look at your emergency savings whenever there is a major change in your finances.
And what if you have to use the money? That is precisely what it is meant for. Once the immediate problem is behind you, start putting money back into the fund. You need not rebuild it in one go; regular monthly contributions can gradually bring it back to the required level.
An emergency fund may not seem like a priority when your salary comes in every month, and everything is running smoothly. But a sudden expense can change that quickly. Having money readily available means you don't have to break investments meant for retirement or other long-term goals just to manage an immediate need.
