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What is an emergency fund?

Emergencies are not at the top of one’s mind when one starts saving. However, their unexpected nature is what differentiates emergencies from other expenses and investments. Often, such expenses tend to be large, and if left unplanned, can cause a severe dent in one’s savings.

The financial provision to cover aforementioned exigencies is known as an emergency fund. Creating such a fund, and ensuring its isolation, can not only come in handy in case of an emergency but also help one avoid having to borrow money.

Why do I need an emergency fund?

There are many reasons people cite to avoid setting up an emergency fund; some of them are: age, limited responsibility, no financial dependents, availability of savings, etc. However, these are not viable reasons as emergencies don’t wait for a certain age or the financial responsibility that one shoulders. Further, classifying savings as one’s emergency fund is just inappropriate as they serve different purposes. Not differentiating one from the other will result into misallocation of financial resources.

An emergency fund is understood to be set aside for primarily health-related issues. However, this is not the case. It can be used for repairing an appliance or gadget that unexpectedly breaks down, including mobile phones. It can also be used to get emergency repairs to vehicles. And most of all, it can come in handy during the unfortunate circumstance of unemployment. Given the career stage one is at, finding a job after losing the previous one unexpectedly can take up to six months or even more. In such a situation, an emergency fund can be a life saver, and that too without denting one’s savings too much.

How much should I save?

In order to build up an emergency fund, you can do a few things:

1. Reduce expenses:

   There is no easier way to build an emergency fund than by reducing expenses. These only include discretionary expenses and impulse purchases. A lot of saving can be done by spending that you didn’t do.

2. Disciplined saving:

   Another great way to save is by setting up a monthly savings target, part of which can be channeled to an emergency fund.

3. Utilizing a second or unexpected income:

   If you can work on an additional job or get an unexpected income in form of gifts, dividends, additional bonus etc., you can use it to build up your emergency fund.

As far as the question of how much to save is concerned, you can look at it in terms of the number of months of expenses. You should have an emergency fund that can cover at least six months of expenses. In order to determine the amount, you should include all recurring, necessary expenses.

You can use online calculators to help you assess how much you need to save on a monthly basis in order to create and maintain an emergency fund.

Orowealth offers its Emergency Fund Calculator which can help you find the corpus needed for emergencies and how much you should keep aside monthly to build this fund. You just need to have your living expenses, the number of months for which you need the emergency fund and the number of months in which you need to accumulate this fund handy in order to calculate this amount.

Where do I put my emergency fund?

Because of its nature, the emergency fund needs to be available on quick tap, thus it needs to be invested in liquid instruments. Therefore, you can choose a savings account which provides a high savings interest rate or a liquid fund to park your emergency fund in.