How to Build an Emergency Fund: A Simple Guide

Over the past four years, due to the COVID-19 pandemic situation, many people experienced salary cuts or even job loss. During such trying times, an Emergency Fund can come in handy and help you tide over such situations with relative ease. Here is a quick guide on how to build an Emergency Fund.

What is an emergency fund?

An emergency fund is a cash reserve that’s specifically set aside for unplanned expenses or financial emergencies. Some common examples include car repairs, home repairs, medical bills, or a loss of income. In general, emergency savings can be used for large or small unplanned bills or payments that are not part of your routine monthly expenses and spending.

Importance of An Emergency Fund

Don’t forget the importance of having an emergency fund. Life is full of surprises—some good, some not so good. In addition to budgeting for everyday expenses, it’s really important to be ready for the unexpected. While you can plan for some things, having an emergency fund can help you handle any surprise expenses that come up.


One unexpected expense could be a situation like the current pandemic. People who have emergency funds are in a much better position than those who don’t when it comes to dealing with unexpected events like lockdowns. An emergency fund can help you stay afloat during tough times, so you don’t have to rely on credit cards or loans. Having an emergency fund can also help you avoid taking out more loans if you already have some that you’re paying off.


Unexpected situations like the current pandemic can be hard to handle without emergency funds. Having savings aside can help you manage unforeseen events like lockdowns without turning to credit cards or loans. It also means you won’t have to take out more loans if you’re already paying some off.

How much emergency fund is required?

Every individual has different financial needs. Each person has a unique combination of lifestyle, dependents, income, and unavoidable expenses. Therefore, the required emergency fund amount will vary for each person.


Before calculating the needed Emergency Fund, it is important to calculate the minimum amount required to cover unavoidable monthly expenses. This should include house rent, loan installments, utility bills, etc. It’s important not to include avoidable expenses such as movies, travel, etc. in this amount.


Once you know your monthly expenses, try to create a cash fund that can help you survive for three to six months without any income. Given the current situation, most people agree that having six months of basic living expenses stashed as an Emergency Fund is essential to manage emergencies efficiently.

How do I build it?

There are different strategies to get your savings started, covering a range of situations, including if you have a limited ability to save or if your pay tends to fluctuate. It may be that you could use all of these strategies. However, if you have a limited ability to save, managing your cash flow or putting away a portion of your tax refund are the easiest ways to get started.


Strategy: Create a savings habit

Building savings of any size is easier when you’re able to consistently put money away. It’s one of the fastest ways to see it grow. If you’re not in a regular practice of saving, there are a few key principles to creating and sticking to a savings habit:
1. Set a goal: Having a specific goal for your savings can help you stay motivated. Establishing your emergency fund may be that achievable goal that helps you stay on track, especially when you’re initially getting started. Use our savings planning tool to calculate how long it’ll take you to reach your goal, based on how much and how often you’re able to put money away.

2. Create a system for making consistent contributions: There are some different ways to save, and as you’ll read below, setting up automatic recurring transfers is often one of the easiest. It may also be that you put a specific amount of cash aside each day, week, or payday period. Aim to make it a specific amount, and if you can occasionally afford to do more, you’ll watch your savings grow even faster.


3. Regularly monitor your progress:  Find a way to regularly check your savings. Whether it’s an automatic notification of your account balance or writing down a running total of your contributions, finding a way to watch your progress can offer gratification and encouragement to keep going.


4. Celebrate your success: If you’re sticking with your savings habit, don’t miss the opportunity to recognize what you’ve accomplished. Find a few ways that you can treat yourself, and if you’ve reached your goal, set your next one.

Where Should You Keep Your Emergency Fund?

Once you have finalized the amount you consider investing in an emergency fund and started working towards saving it, it is important to find a good place to keep it. A savings account is a logical choice since it offers liquidity, which is highly important during a crisis.


Look for a savings account offering a high interest rate with no minimum balance requirements or heavy fees. However, since you will not need the emergency fund regularly, you may consider investing a part of this fund in an instrument that offers high liquidity and better returns than a savings account. Some mutual funds offer easy liquidity and better returns than savings accounts while keeping risks minimal. These are called liquid funds. By investing a sizable part of the emergency fund in these schemes, liquidity is ensured since you can redeem it within a couple of days. Average returns on liquid funds hover around the 6-8% mark.


Another important aspect of an emergency fund is building it. For example, if your basic living expenses are Rs. 40,000, you will need to save between Rs. 2-2.5 lakh as your emergency fund. Considering the increasing costs of living, this can take time. You can reach this goal faster by using a debt mutual fund. With low risks and an opportunity to earn good returns, these funds can help you create the corpus in a shorter period. You can consider starting a Systematic Investment Plan (SIP) and automating your savings and investments. You can also invest your annual bonus in these funds to reach the target sooner.


In today’s world, many people aspire to achieve financial independence at a young age. They aim to retire in their forties and have all their financial needs covered.


This goal requires thorough planning and strategic investing, starting with establishing an Emergency Fund to cover unforeseen expenses shortly. While this may seem unnecessary during normal times, it can be incredibly beneficial during emergencies like the current lockdown.


If you have not started yet, then let this year be the one you begin your journey of building an Emergency Fund. Happy Investing!

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