As we have explained in our several articles, everyone, individually or as a family, should have an emergency fund to deal with the unforeseen events and setbacks in life. But, what is an emergency fund in personal finances? How much money should this emergency fund be made of? How long should it cover us?
What is an Emergency Fund?
It is an amount of money that we must have set aside but available in liquid form to cover contingencies and emergencies in our finances so that, in the event that tomorrow we stop receiving income, it could cover our fixed expenses for a few months. When we say that the emergency fund must be liquid, we mean that we can have it from the next day without losing assets value or being penalized for the withdrawal of this money.
In other words, if we had money destined for the emergency fund in shares, if we needed it when the shares have lost value, we would be losing money at the time of withdrawal. Therefore, it must be totally liquid.
How long should the emergency fund cover?
Calculate the expenses and economic needs that you have each month: electricity, water, food, travel etc … the emergency fund must be able to cover those expenses for 12 or 6 months in case we do not receive any income during that period of time without the need to sell any of our personal properties. The emergency fund will not make us avoid such problems that appear unexpectedly, but it will help us prevent that problem from becoming a new problem.
It is estimated that more than 70% of people do not have savings to cover more than 3 months in case they stop receiving income tomorrow. And that is a sign that your finances are not healthy.
Not having an emergency fund, as well as high debt, are among the biggest mistakes we make in our personal finances. And taking debt is also a sign that your finances are not healthy.
How much money should we save in this emergency fund?
There is always a need of minimum 2 to 5 lakh Rupees, but if we go to the point above, the emergency fund will depend on our current lifestyle. Some families have such an economical lifestyle that with just 2 lakh Rupees they could survive for 6 months. Other families have fastened expenses that they would have to have a fund of 5 lakh rupees and that they could not even cover for two months.
So more than a specified amount of money to save in the fund, we should impose the time that must cover us. To have an Emergency Fund in conditions and finances prepared for an economic crisis, once all our fixed expenses have been calculated, it should be able to cover us for at least 6 months.
The main reasons for having an emergency fund would be:
1. The psychological factor in the face of the disaster.
When we talked about how to deal with a personal financial crisis, we explained that everyone will go through this situation at some point in their life. The first point to deal with it was to avoid panic and think in a relaxed and intelligent way. You will hardly be able to avoid panic if the moment you suffer a setback. Your financial problems will be in front of you in a matter of weeks when you are living from day to day with any income.
Avoid making miserable decisions, as these decisions rarely come to realization. An emergency fund will give you that peace of mind and stability, as well as the patience necessary to develop a next strategy.
2. Loss of employment.
Some see it coming, while others are taken by surprise. When our economic situation is good, it is when we must look for alternative sources of income and plan our emergency fund. Remember that sooner or later things always get worse, and the only way to avoid that impact is to prevent it in advance.
3. External factors to ourselves.
The world economy or national economy can cause our bills to go up. We can find heavenly price rises in basic products, electricity, water, etc … and this situation also clashes with a decrease in salary by our company to prevent employees from being laid off.
Our income decreases and the cost of living rises. At that point, when such situations begin to appear, our emergency fund can be the neutralizer to lessen the damage. Sooner or later, you will thank yourself for this.
4. Contingencies in vehicle and home breakdowns.
Our car can break down at any time, and repair can be expensive. In more extreme cases, we may have to replace it entirely. Likewise, in the home we can suffer from a small breakdown to major tragedy that are not covered by insurance. Such as boiler, heater, stove, wall damage, plumbing breakdowns etc. The emergency fund will prevent us from having to use credit to pay for such breakdowns or disasters.
5. Diseases.
If you are self-employed, the emergency fund is a priority for you, because being sick will cost you money. Similarly, for pet lovers, vets don’t come cheap. Therefore, sooner or later, you will definitely need an emergency fund for this.
On the other hand, if we receive a call that a relative from the other side of the country has died and we have to go to their funeral, the last thing we would like to worry about at that moment is the expenses of that trip.
In short, the emergency fund will not make us avoid certain problems or disasters that appear unexpectedly, but it will help us prevent that problem from becoming a new problem. Therefore as we have discussed above, everyone should have an emergency fund to deal with the unforeseen events and setbacks in life. Although some believe that it does not help a lot, both in good times and in bad. The decision to avoid your inevitable financial setback is still in your hand today.
