Life rarely follows a set-out plan. One moment everything is going great and the next moment all hell breaks loose. It is true in life as per Murphy’s laws “Anything that can go wrong will go wrong ” and “Everything goes wrong at same time” .
It was in my early career when I realized the importance of emergency cash fund. I was in my first job and my salary was good enough for family expenses and little savings. Suddenly, my mother had to be operated and it came out of nowhere. I had in the previous month paid my sisters’ college tuition fee of Rs 50,000.
So, I had mere Rs 5000 cash left in my savings account when the medical expenses were around Rs 1,20,000. Fortunately, one of my friend helped and for the remaining I sold few of my stocks, pawned my mom’s gold jewels at 24% interest p.a to meet the cash requirements. This was the situation which made me accept why one needs an emergency cash fund & health insurance.
Many of you might have faced similar situations like kid’s school fee, medical emergency, sudden car accident, loss of job. Due to sudden financial needs you might have had to borrow from friends and financial institutions. It is in these type of situations that an emergency fund can be a real life saver if you had planned for one.
What is an Emergency Fund
If you have never heard of it, an emergency fund is like your insurance policy when the financial blanket is pulled right from under your feet due to any emergency.
It is an account where you set aside some funds so that should you ever be in an emergency, you will have something you can fall back on.
The main purpose of such funds is to secure your financial security and act as a helping hand when let’s say, you lose a job or fall ill. However, it’s not that you set up an emergency fund fully expecting to get fired next week, but you set one up to soften the blow, so to speak.
There are various benefits of having a little cash stashed away for a rainy day. It helps avoid high-interest debt you might have to take should you get a financial emergency or embarrassing moment where you had to borrow from friends & family .
During such moments, you have no other option available as you cannot postpone your expenses or close your eyes as if they don’t exist. A loan from the bank, for instance, might take a whole day/week, and you need that money now.
So off you go running to local money lenders, who charge an arm and a leg in interest or dialing friends for help. An emergency fund helps you avoid this so that when you get back on your feet, you don’t have to struggle paying back interest to lenders.
Secondly, an emergency fund is your ticket out of bankruptcy or defaults.
Maybe you took out a bank loan and now you cannot repay it. There is no way you will avoid bankruptcy/defaults here.Don’t think bankruptcy as some big term. It is common in the US . In India it is often referred as defaulter (for lack of equivalent word).
It is the time when you fail to pay your EMIs or expenses on consistent basis and your credit score goes for a toss and you give up helplessly ending up with legal cases filed against you.
However, as Brad Smith, the CEO of Rescue One Financial a debt management company recently pointed out, most people eligible for bankruptcy can avoid it they have any emergency fund set up. However, our elders like mom and dad have taught us the same thing well in advance.
The words ring true in almost every corner of the globe. There are lots of people living from salary to salary that any serious expense might ruin their financial position. Some additional funds could easily handle those kinds of situations.
Now that we all agree emergency funds can be a life saver, let’s look at how you can build yours. Below are steps on how to build an emergency fund and avoid unexpected events leading to your financial ruin.
How to build your emergency fund
You should know that the first step is always the hardest. After that, the second and third step will be a relatively easier if you’re committed. After all, no debt will be hamstringing your income and there is nothing to disturb your peace of mind.
Second, it’s a lot easier to save knowing that you are responsible for your own financial stability. With that said, here’s how you can build up your emergency fund.
- Offload Something or don’t buy what You Don’t Really Need
Probably you saw this coming a mile away. So we won’t get into the merits of selling off some stuff you can probably do without to secure your financial future. However, we are pretty sure if you take a moment and look around your home, you will probably be blown away by how many items you could turn into instant cash.
It might be some of your kid’s old toys, furniture you no longer use, or the treadmill you promised to use. Just think about it, it’s a great source of quick cash to get your emergency fund started.
Also think if you really need that next iPhone model when the one you have already is working well without issues. Not just iPhones, avoid binge shopping. How many times have you wondered how all the money got spent during weekend when you had no plans to buy anything when visiting the mall.
Tip: Go to single screen movie theatre for watching movies. Instead of going to the mall, why not develop the habit of games with family or beach, park that are relatively inexpensive. And when you do go to the mall, leave your credit card at home and take only limited cash. You’ll be amazed how much you save.
- Get a Second Job or income
Most of you by now are going “Now just wait one minute. I thought you were supposed to show us the path to a secure financial future, not work to death!” The thought of putting in extra hours is not pleasant, especially when we are already beaten.
An extra job keeps you away from your family, you cannot hang out with your buddies, and your wife will probably give you stick for being away all the time. But, there is an upside.
A second job makes a tremendous difference should Murphy’s Law decides to tap dance on your face. In such situations, you will be relieved you put in the extra hours. A second job can be a 2 or 4 hour shift nearby your home.
All that matters is the second job does not break your back, nor does it do more harm than good. It helps you build up your emergency fund quite rapidly and even helps you cut back on some nasty financial habits, as discussed in the next step.
Tip: Consider teaching what you’re good at. Also if you’re more entrepreneurial think about starting an evening business. I used to recruit and send teachers for private tuition and take a cut from what they earn. It was only 2-3 hrs job a day once I had the website set up.
I used to advertise in local papers, had a website where qualified teachers can register. Parents call seeing advertisements and I used to send multiple teachers for interviews and parents can choose the tutor they want. It was hard work but not rocket science. Serve with the client in mind and you’ll be rewarded. My friend working in IT MNC, used to run soup shop with traditional snacks in the evening near beaches and it was a hot business. He now runs 6 kiosks like that.
- Budget Cuts
Take a look at your budget and cut little pieces from a bunch of your expenditures. They should be pieces you don’t notice individually, but they should add up to a tidy sum.
Thirty rupees is not a tidy sum by our definition. You’ll hate it initially, having to turn down the thermostat a degree or two, or having to remember to turn every light in the house before you leave. Or cut back on your pizza or washing your own car.
There are also those unplanned miscellaneous expenses that pop up in your budget. Minimize on those as a way of cutting back. Remember, however, we are not telling you to skip meals.
Tip: Cutbacks are small things you can do without, like that movie every other weekend or booze party every Friday. Spread it out or skip one/two weekendmovies in a month. But trust us, those little cuts will bring big payoffs. You might be surprised at the end of the year on total savings.
- Hunt for Extra Income and Passive Income Opportunities
Relax; we are not going to ask you to get a third job. This is a tad bit different. You know that thing you love doing? Painting, baking, playing around with electronics? Well, you can turn that into a source of extra income.
You can take your paintings to galleries and see if they will take it. If they are any good, they will, and you end up with a tidy sum in your hands. On the other hand, you can take your love of electronics and use it to help friends and family repair stuff around the house, for a fee of course.
There are thousands of hobbies you can turn into a source of extra income. Find yours, and do it. You can even write short stories and sell them.
Why not set up a website about what you love. This website was set up that way. My friend set up a website about cooking and has 8k subscribers for her Youtube channel. I watched her channel to learn cooking like sambar, chutney, fried rice when I was abroad.
I hope you must have same experience even if you wanted to try a new dish. If your stuff is good and there is reasonable demand, it will do well. I will do a separate post on how you can make money with websites separately.
Our word of advice is, follow these steps in any order you want. None of them is particularly more important than the other. All that matters is you see each one of them through.
Remember, as mentioned earlier, the first step is always the hardest. But when you accomplish it, everything else becomes a whole lot easier.
How Much Emergency Fund is ideal?
Now this is a tricky question that even gurus can’t agree on. Some money experts suggest that your emergency cash fund account should have a minimum one year worth of your monthly expenses. To me, this seems like a bit of overkill.
Yes, we will be the first to admit, over-saving has never been a bad thing. But stashing one year worth of your expense is not the best use of your money. Let squirrels stash all their nuts for one year, our advice is at least three to six months worth of your monthly expenses.
It should cover all regular medical bills, insurance premiums(both term and health), entertainment cost, transportation, rent, groceries, mortgage EMIs etc., Therefore, six months worth of expenses saved up plus a little knowledge of money should keep you pretty safe.
But if you’re venturing into a business after resigning your job, then 2-3 year of expenses is my advise for emergency fund corpus.
Tip1: If you have a high-interest loan like credit card or personal loan, then keep 2-3 months as emergency fund and try to pay off your loan first. Once done with your loan,you can gradually increase your emergency fund to 6 month expenses.
Tip2: Remember that emergency fund and insurance is always a multiple of your expenses and savings/investments should always be a multiple of your income. For eg., your emergency fund can be 6 month worth of expenses but not 6 months income. That is not right way to plan.
Where to Keep Your Emergency Funds
Now that we have covered some simple ways of raising some cash for your emergency funds and how much is needed, let’s check out where to keep it.There are 2 things to keep in mind when parking an emergency fund.
1) Liquidity – Funds saved for emergency should have reasonable liquidity. Else there is no point in having it. What good if it is stored in illiquid instruments and take time when you need them. Don’t argue my worth is in real estate and it will cover my emergency. Try to liquidate your house in emergency and you’ll know what I mean.
2) Less Risk – They should have little or no risk. Like savings bank or short term deposits. Stocks, real estate, long term FD are a no-no. Why not FD? Because they’ll usually have penalty or no interest for premature withdrawal.
I advice splitting your emergency fund into two. One is easy access emergency fund and next is long term emergency fund.
Same day Emergency Fund – You want to go with a bank here, preferably a savings account with debit card. Banks are your best bet because they give you interest on your money.Put in two to three months of your expenses in this fund.
Better to open a separate high interest bank account for this and then lock your attached debit card in cupboard locker. Don’t keep the debit card in your wallet. Only take this card out for a real emergency (more on this below).
Next day liquidity fund – This fund should only be touched when you lose your job or medical emergency. It should be in Company CDs or better good liquid funds. This way it is still liquid but you’ll have to wait one-two days to get cash in your bank account. Keep 3-4 months expenses in this account. Check out below link for good liquid funds.
Talk to your financial advisor about which of these options are best for you, however, before settling on one. However, no matter which option you select, always make sure that your money is fairly liquid so that should an emergency pop up, you can easily access it.
Therefore, whichever option you go with, ascertain its liquidity first before committing. Also, you do not want your emergency fund tied up in volatile markets such as stocks or equity mutual funds.
Remember when I said I had to sell stocks to meet my emergency. I sold the stocks at 30% loss though they were good quality stocks because markets were in a bear phase during that time. I would not have sold these stocks at a loss if there was no emergency.
Common arguments against emergency funds
1) I have a credit card – I have a credit card and I will swipe it during emergency. Credit card is good when used in a right way. Yes, you can/should use it for immediate expense like paying at the hospital reception. But remember you always have to pay the bill at the end of month. For this you’ll definitely need the emergency cash fund.
2) I will pawn jewels – Gold jewels are easily liquid and I will pawn them when there is an emergency. Yes, while goal loans are available easily but they come at a higher cost typically 14% from banks and 24% from private lenders.
3) Emergency fund gives less less interest – This is a common argument ‘Emergencies rarely happen and there is no use in tying up funds in low interest places.When it happens I will manage’. We can’t argue with those having this attitude. While everybody has their own approach , the above usually may not be the best approach.
Remember, the idea of an emergency is to have cash for emergencies and not earn interest. However, there is no wrong in optimizing returns from an emergency fund as long as it serves the purpose. We have already discussed on how to make best use of emergency funds
What is a real emergency?
Now that we know how to build an emergency fund and where,how to save , we should also decide what is true emergency. You should not consider the following as emergencies.
- Gift to your wife on anniversary
- Dream vacation abroad
- Treat to friends on getting your promotion
- Upgrading your car or home or latest gadget
- An investment opportunity at mouth watering valuation
Learn to let these go. They can always be had at a later date. This is not a complete list by any means. You should have already got the idea by now..Now let us see what is a real emergency.
- Medical emergency or accident to you or any immediate family member
- Loss of job
- Car accident and damage to your vehicle (relatively lesser emergency)
So, it is up to you to decide if the situation you’re in is a true emergency or not. Use your judgement and decide yourself.
Now that you know the aspects of planning for an emergency fund, do not sit but actually execute. Build up your emergency fund for that rainy day.
Did you like the post on Why, Where How to build an emergency cash fund ? Did you face a similar situation like me without an emergency fund? How did you overcome it and how have planned for future emergencies? Let us know below.