Best Tips to Assess & Create your Emergency Fund

• 7 May 2020 | 1151 Views | By Mansi Jain

Your money and the way you manage it always has a significant influence in your present lifestyle and the quality of life that you are expecting to have in the future. Learning how to properly manage your money is an important skill that you must learn to avoid making bad financial decisions and choices that can hamper your entire life. Developing and implementing a financial plan along with creating and setting aside an emergency fund is a crucial step to successfully manage money. 

To get ahead financially, you should spend less than what you are earning and put off a certain portion of your income for savings, emergency, investment and retirement. However, to be financially healthy now and in future, it is important for everyone to take responsibility for managing his or her own money.  

Current coronavirus outbreak has thrown a spotlight that having an emergency fund is a necessity in our lives. Most financial experts say that the emergency fund should be able to cover three to six months’ worth of your household expenses. 

BUILDING AN EMERGENCY FUND

The first step in the process is to determine and list down your monthly expenditures ranging from household expenses to monthly payments, amortizations or loans and miscellaneous expenses. Also make sure to categorize the expenses into necessary and unnecessary expenses as this will help you in determining realistic amount that is required as an emergency fund and it will also help in chalking out the unwanted expenses.

The second step in the process is to assess and analyze all sources of your income. It is important for people with multiple income sources. Also consider differentiating your sources of income in regular source of income and variable source of income. For example, your monthly salary will be your regular source of income and the yearly bonus will be a periodic income or variable income. Your main source of monthly savings should be from your regular source of income and variable income should be used to make lump sum investments.

How to save for Emergency Fund if money is tight?

After you have analyzed your monthly expenses and income, you need to assess the monthly savings you are making and make sure to check whether the current rate of savings you are making is good enough or not. Always try to improve your savings rate by cutting down on unnecessary expenses and assessing the areas you are spending more than required. There is always a room for improvement when it comes to savings, it is an ongoing process. Also, you should try to improve your rate of monthly savings according to the gradual increase in your income. 

How much should you put in Emergency Fund each month?

Ideally, you should save at least 10% of your monthly income. A good strategy is to pay yourself first as soon you receive your salary or income. We work hard and deserve to be paid ahead of billing companies, vendors and banks. Although don’t try to make all the savings required to build an emergency fund in one month, everything takes time to build, a house, a relationship and so does your fund. Also, one of the important things while building your emergency fund is to make the savings a hobby.

The next step will be to save on your bills and daily expenses. It will prove to be one of the easier ways to improve your financial health. One of the proven strategies and tips that can help you save money is to “Live within your means”. There is no sense in having the latest iPhone model if it will just make you a slave to your credit card. Instead, always invest in the thing that will last and appreciate in value.

What kind of account should I put my Emergency Fund in?

Once you have decided on savings, the next big step is to pick the right place to keep your saved money. Ideally, it should be easy to access and withdraw and should be maintained in cash and cash equivalents. There, are several other savings vehicles which can be considered to keep your Emergency Fund, below are some of the vehicle you can consider.

1. Savings Bank Account

As a first step you can start with savings bank account which gives a stable interest rate. You can deposit money on a monthly basis and keep earning interest. Once you have substantial savings you can invest in liquid funds such as money market fund or mutual funds. 

The most popular and common way is to keep your money in a savings bank account. However, people do not realize here that it is fully taxable and yields comparatively low interest (4.5% per annum currently). So, a better way to create an emergency fund is by opening a fund account in mutual funds. It is more tax-efficient, the returns are slightly higher (around 5.5 – 7.5% p.a.) and can be withdrawn on a very short notice. 

2. Fixed Deposits

Another way is to invest your money in Fixed Deposits. Fixed Deposits’ offer a fixed rate of return and can range from 30 days to 10 years depending on the term you choose. The rate of return is guaranteed in a Fixed Deposit which can help you earn extra interest on your emergency fund. The Fixed deposit consists of an early withdrawal penalty if you withdraw money before the maturity which is a drawback of investing in it. However, if you create a Fixed Deposit ladder i.e. investing in multiple Fixed Deposits with different maturity dates which may help you avoid the said penalty or fee. 

How much should you have in Savings at 40??

Now after reading about the emergency fund and savings, you must be wondering ‘What is the right amount of savings?’. At the age of 40, you are halfway towards your retirement and by then you should have a considerable amount of savings and just not an emergency fund of three to six months. There is no perfect answer to this, however a reasonable amount would be 2.6 times of your annual salary.  It mostly varies based on where you live and your lifestyle. A retirement that is stress free and relaxing is a wonderful reason for savings, but it is not the only reason to build a savings or an emergency fund. 

Explore best options to invest in your child’s future in this article.

Life events, social and economic landscapes may require you to adjust your financial plan. But it is important to re-evaluate the plan periodically to make sure that it is relevant in the present situation. Whenever there is a change in financial situation you must revisit your emergency fund to make the required changes.

As we all are aware that currently the world is hit by a pandemic due to which our economy is also badly hit and, in such crisis,, we need an emergency fund as “Your emergency fund is not an investment, it is an insurance to protect your family”.