Financial security: The importance of having a 6 months emergency fund

When it comes to saving for emergencies, you must not aim for high returns. Know that high returns come with high risks. You should always prioritise liquidity, ease of access, and security when storing your emergency funds

Shailesh Khanduri
09 Jan 2023
Financial security: The importance of having a 6 months emergency fund

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New Delhi: The concept of a contingency buffer is simple and old, but it is still effective. You put money aside for uninsured, unexpected, unplanned, and, most importantly, expensive emergencies. These can include unexpected repair costs, medical expenses, and travel expenses, among other things. Sometimes the emergencies of your extended family become your own, and you need to open your wallet.

As a result, consider it a rainy day fund. The same as a raincoat. You won't need it on most days. But if it does and you don't have one, you're screwed. Returning to the subject, isn't a six-month expense buffer sufficient? It is for many people. But it is not for everyone.

This is because, due to a variety of factors, some people should ideally have larger emergency funds. Let's look at why a bigger emergency fund is necessary.

Risk of losing job and income consequently

You can live with a smaller emergency fund if you have a secure, guaranteed-for-life government job. For example, up to three to four months' worth of expenses. This is due to the low likelihood of job and income loss. If you work in industries/sectors or even countries (such as the Middle East) where layoffs are common and reemployment opportunities are scarce, you will need a larger buffer. Expenses should be considered for periods ranging from nine to 15-20 months.

Number of dependents in your family

If you are the family's sole earner, you understand how a loss of income or a large expense can derail your entire family budget. However, if you and your spouse both earn well and have few dependents, the possibility of both incomes ceasing at the same time is extremely remote. As a result, if you have a large number of dependents and/or are the sole earner, a larger buffer is preferable. To begin, make sure you have a 6-month emergency fund. But don't stop there. Increase this fund gradually over a period of 9-12 months. This can be achieved by setting aside money each month (for example, through RD) or by utilising a portion of your annual bonuses all at once.

Your dependents’ needs

Your needs will be different if you only have your spouse and one child versus someone who has a spouse, two children, two dependent parents, and occasional in-law dependency. Isn't that correct? Many people rely on their elderly parents, and they also have ongoing medical expenses (which are not covered under health insurance). A larger buffer is always preferable for them.

Furthermore, all of the above factors may have an impact on you. If this is the case, put increasing the size of your emergency fund ahead of all other objectives.

How to build up your emergency fund?

When saving for emergencies, you should not aim for high returns. Remember that high returns come with high risks. And you don't want to be in an emergency situation where you need money but your money is now parked in losing instruments. You should always prioritise liquidity, ease of access, and security when storing your emergency funds.

A separate savings account and fixed deposits are adequate for small sums. Liquid funds can also be included if you want to set aside a larger corpus for emergencies. Also, don't consider your credit cards to be emergency funds. Because you will have to repay the money once the bill arrives. Credit cards can be used for emergency expenses, but the bill must still be paid with an emergency fund.

Plan an emergency fund to protect your savings

That's unusual. However, it is correct. If you have an emergency fund, you won't have to dip into your other long-term investments. This way, your savings for other goals are preserved and no unnecessary withdrawals are made.

We can say you should have a larger buffer much more easily than we can put one in place. However, if your situation calls for it, you must do so. Make the best of it, but don't make it your strategy. Plan ahead of time and stock up on emergency supplies. As a result, you will be better able to manage unexpected expenses in the future without making sacrifices.

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