Emergency Savings: Building a Financial Cushion with Emergency Fund
July 22, 2024
Let's assume Mr. X has a well-paying job. He is the sole breadwinner for his family of 6, which includes him, his spouse, two children and senior citizen parents. One day, Mr. X unexpectedly loses his job. Suddenly, Mr. X's main source of income is gone. He has bills to pay, including home loan EMI, children's school fees, and other essential expenses. Sounds like a stressful situation, right? But Mr. X doesn't panic - he knows he has a runway of another 2 years - thanks to the emergency fund he had built over the years.
However, such is not the case for many Indian. Did you know that a staggering 75% of Indians don't have emergency funds? The numbers are alarming. Having a savings corpus set for emergency funds can help you sail through tough financial situations.
In this piece, we have provided a few tips you can consider to build emergency savings fund for a stress-free financial life.
Emergency Savings: How to Build a Financial Emergency Fund?
Step 1: Determine How Much You Need
The first step in building an emergency fund is determining how much you need to set aside. While there are thumb rules suggesting that your emergency fund should be six to nine months of your fixed monthly expenses as a benchmark, however, this may differ based on your lifestyle, financial obligations and other such parameters.
Let’s understand this with examples:
Example 1: A double-income family with monthly expenses of ₹50,000 should aim for an emergency fund of at least six months' expenses (₹3 lakh).
Example 2: On the other hand, a single-income family with the same expenses may need 10-12 months' worth (₹5 - ₹6 lakh) to ensure financial stability.
To calculate the minimum amount needed for your emergency fund:
- Focus on unavoidable monthly expenses such as rent, EMIs, utility bills, etc.
- Exclude discretionary expenses like entertainment and travel from your calculations.
- Once you have this figured out, aim to create a cash fund that can cover three to six months of living expenses without any income.
Step 2: Choose the Right Investment Option
Ideally, your emergency savings should be easily accessible. Consider investment options that are safe from market fluctuations and provide stability. Let’s look at few options:
Option 1: High-Yield Savings Account
- Provides immediate liquidity during crunch situations
- High-yield Savings Accounts can help your emergency fund grow faster
- Easy to maintain and access
Option 2: Fixed Deposits
- Safe investment option with stable returns
- Offers greater flexibility in terms of tenure and withdrawal options*
- Amount up to ₹5 lakh insured under DICGC (Deposit Insurance and Credit Guarantee Corporation)
*Ujjivan SFB doesn't levy any penalty on its Fixed Deposits for withdrawals made after 6 months from the time of investment. Please note: Premature withdrawals are not applicable for non-callable FDs.
Recurring Deposits
- No penalty charges for premature withdrawals
- One of the best investment channels to build emergency corpus
- Brings discipline in saving money
Debt Mutual Funds
- Low-risk investment option compared to equity funds.
- Provides steady returns and stability.
- Ideal for maintaining the value of your emergency fund while earning moderate returns.
- Start a Systematic Investment Plan (SIP) to build your emergency fund over time with disciplined investing.
Disclaimer for Mutual Funds: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
Step 3: Automate Your Savings
Building an emergency fund requires consistency and discipline. One way to ensure you're saving regularly is by automating your investments. Schedule automatic transfers from your primary account to your emergency fund savings account so that a portion of your income is diverted towards the account as soon as you get your salary. This eliminates the need to remember and manually transfer funds each time.
Consider setting up Recurring Deposits or Systematic Investment Plans (SIPs) that automatically deduct a fixed amount from your account at regular intervals. By automating your savings, you make it a non-negotiable expense and develop a habit of prioritising financial security.
Step 4: Sign up for a Comprehensive Insurance Plan
Healthcare costs in India are rising rapidly. A few days of hospitalisation can take a toll on your finances. Signing up for a comprehensive insurance plan could help in providing financial protection against unexpected events like medical emergencies.
Remember, insurance should complement but not replace your emergency fund. Insurance is not designed to cover day-to-day expenses, making an emergency fund necessary for financial stability.
Step 5: Using Your Emergency Savings Wisely
Use your emergency fund exclusively for genuine emergencies to maintain its efficacy. Establish clear guidelines for accessing these funds based on specific situations, such as medical emergencies, essential home repairs, or temporary income loss due to unforeseen circumstances.
These parameters prevent impulsive or unnecessary spending that could deplete your emergency fund prematurely.
Emergency Savings: 3 Major Don'ts When Saving for Financial Emergency Fund
1. Don’t Live Beyond Your Means
Avoiding overspending is crucial, especially considering lifestyle inflation, where expenses tend to rise with income. It's essential to budget wisely, and prioritise needs over wants.
2. Don't Fall into the Debt Trap
Debt trap happens when you pile up credit card bills or take out too many loans beyond your repayment capacity. It's considered as a vicious cycle that could lead to tremendous financial stress.
3. Don't Treat Your Health Insurance as Your Only Safety Net
One major mistake people make is that they treat their health insurance as a replacement for an emergency fund. While health insurance covers medical expenses, it may not suffice for other unforeseen financial needs.
Final Thoughts
In today's day and age, emergency savings are extremely important for financial security. Build a robust financial emergency fund and handle life's unexpected curveballs effectively.
If you're just starting out in your savings journey, opening a Savings Account with Ujjivan Small Finance Bank can be a good start. We have a wide variety of Savings Accounts catering to different financial needs - sign up for the one that meets your financial goals. Alternatively, you can browse through Ujjivan SFB product suite - our wide range of financial products are designed to make your financial life better.
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