4 Steps to Build an Emergency Fund: A Step-by-Step Tutorial
If you have been thinking about starting an emergency fund, here’s a step-by-step tutorial for you.
4 Steps to Build an Emergency Fund
While financial experts have been emphasising the need for building an emergency fund for quite a while, it had not been felt as acutely as it did this year when COVID-19 induced lockdowns hit the globe. Many people lost their jobs, some lost the perks they heavily depended upon for maintaining their lifestyle while many businesses closed down or went into debt.
On a personal level, people have been facing quite a few challenges. If planned and executed well, an emergency fund can come to the rescue in such similar circumstances in the future.
Some people do not know what exactly an emergency fund is and how to build it. So, let’s start from right there.
What is an emergency fund?
It is a sum of money set aside in a liquid fund that you can access easily in times of need. Ideally, it is a sum of money that can cover your living expenses for at least 3 months. If you are the sole breadwinner in the family then it is advisable to build a contingency fund that can cover your living expenses for 6 to 12 months.
How to build an emergency fund?
A little frugality and a little planning are all it takes to build an emergency fund. Today, we are going to give you a quick tutorial to build an emergency fund.
Here it goes:
Step 1: Take note of your monthly income and expenses. You must include all sources of income, however small, as well as expenses. Divide expenses into essential and non-essential. Keep a fine balance. Netflix subscription is not a part of essential expenses in most cases unless of course it is the primary source of entertainment.
Step 2: Next step is to set an emergency fund goal. It should cover at least 3 to 6 months of your current monthly expenses. Start with a goal to have a fund that covers expenses for a month and then build it from there. This will help you get to the larger goal one step at a time.
Step 3: Plan to reach your emergency fund goal in a realistic and achievable time frame. Ideally, you should aim to build it within one year. This is usually more than sufficient time. If say your monthly living expenses are Rs. 30,000, then it is comparatively easy to get to Rs. 90,000 or even Rs. 1.2 lakh by putting aside Rs. 10,000 each month.
Step 4: Stick to your plan and do not stop until you have achieved your goal. You can move to investing your money and building your wealth in the same fashion after you have built your emergency fund. This way you can build up an emergency fund that lasts you for at least a year at least. Once that is done, you can move to build your wealth or retirement corpus with the same saving and investment strategy.
Learning with Examples
Let us understand the overall process with an example.
Let us suppose your monthly household income is Rs. 65,000 and your monthly expenses including mortgage, utility bills, childcare, entertainment, etc. add up to Rs. 50,000. This means that you can save up to Rs. 15,000 per month. Since your total monthly expenses are Rs. 50,000, you need to build an emergency fund of Rs. 1.5 lakh at first to meet your needs for 3 months (Goal 1) and then set a target of Rs. 3 lakh to meet your needs for 6 months (Goal 2).
If you keep putting your savings of Rs. 15,000 every month in the emergency fund, you will be able to achieve Goal 1 in 10 months. If you keep at it, you can meet Goal 2 in 20 months.
You may not believe us now, but once you have achieved these goals, you will yourself feel a sense of pride and achievement and become relatively stress-free.
Once you have successfully built an emergency fund, you can move on to investing in different types of assets and start building your portfolio. Your emergency fund will give you the confidence to take small risks and grow in life. Even in situations like loss of a job, you will not lose heart since your emergency fund will buy you extra time to look for a suitable job or even start a business.
So, would you like to build an emergency fund?