Emergency Fund - your insurance policy against financial calamity

An emergency is defined as a serious, unexpected, and often dangerous situation requiring immediate action. An emergency fund is a pool of money set aside for the unexpected events in life which require money.  It is not an investment, instead, it is an insurance which has just one objective - to give you and your family peace of mind and confidence that you can tackle any of life's unexpected events without adding financial worries to your list. This is one of the most important parts of financial planning and it should be the priority no.1 task in building your financial future.

Top Two emergencies I can think of:

• Job Loss/ Sudden loss of Income:  In event of job loss, you will still have to pay for non-discretionary expenses like utility bills, children's tuition fees, food etc.. Remember everyone feels secure in their jobs until they get fired.

• Medical Emergencies: In the event of a medical catastrophe, the medical expenses may overshoot your medical insurance coverage, but you still have to pay for medical expenses for your loved ones.  

Now that you have understood the importance of having an emergency fund, you should immediately start saving for it. You may decide to reduce your investments for some time so that you can accumulate the desired emergency fund fast. Sometimes, I am asked that "I already have many credit cards with me for an emergency situation?". In the absence of emergency funds, you will be using your credit card, thereby increasing your debt, or having to pay hefty late fee charges levied by credit card companies. In difficult situations such as Job Loss, if you are not able to pay in full to the credit card company, you will end up carrying a balance over to the next month, and this could get very expensive as well as stressful. In my view, credit cards are not an emergency fund.

Another common question is how much should I have in my emergency fund? There is no right answer to this question. The size of the emergency fund will depend a lot on your non-discretionary monthly expenses. In case of job loss, we all know that finding a new job is tough nowadays, therefore it is a good idea to have at least 9 - 12 months work of non-discretionary expenses kept aside as emergency fund, especially if your family depends on a single income or there are EMI outstanding for your home or car loans. 

The most important rule of an emergency fund is that it should easily accessible (liquid). I would say the best place to accumulate and keep your emergency fund is your saving bank account. You can open a recurring deposit to accumulate the corpus needed for an emergency fund and then put it in a fixed deposit.  However, If you think you are not disciplined enough and might end up using the funds from saving bank account, you can go for Liquid Funds.

With an emergency fund in place, you will be able to ride out events that can't be anticipated. As I said, it is like an insurance ( I hope you never need it ), but if you need it and you do not have it, the consequences can be quite stressful.  As they say "Cash is always important to have, whether it is for an emergency or an opportunity" . So start building up your Emergency Fund from today.