How to build an emergency fund: A step-by-step guide
5 May 2023
We’ve all experienced unexpected financial emergencies—a fender bender, an unexpected medical bill, a broken appliance, a loss of income, or even a damaged cell phone. Large or small, these unplanned expenses often feel like they hit at the worst times. Setting up a dedicated savings or emergency fund is one essential way to protect yourself, and it’s one of the first steps you can take to start saving. By putting money aside—even a small amount—for these unplanned expenses, you’re able to recover quicker and get back on track towards reaching your larger savings goals.
What is an Emergency Fund?
An emergency fund is a savings account dedicated to covering life’s unexpected expenses.
No matter how careful you are about managing your money, there will eventually be something that comes up where you need a little extra help.
The trick is to be prepared for it. An emergency fund doesn’t have to be a massive savings account with a huge balance. It can be as little as ₹ 1 Lakh or as much as ₹ 5 Lakhs, depending on your financial situation, lifestyle and expenses. An emergency fund is just enough money to cover those unexpected expenses that life throws your way, like a car repair or an insurance deductible.
Why having an emergency fund is important?
Having an emergency fund is one of the most important aspects of personal finance. There are a lot of things that can go wrong in life, so having a fund to cover those unexpected costs will help you sleep better at night.
An emergency fund is there for you when you need it most. You may not feel the need to tap into it frequently, but it’s important to have one because emergencies can add up quickly and become expensive. Consider it holy, it must never be touched unless you need the money to feed yourself and your family.
Let’s look at some of the reasons an emergency fund is so important: You’ll have money to pay for unplanned expenses. Life happens, and unexpected expenses can crop up at any time. Having an emergency fund ensures you have the funds you need to pay for these expenses without having to take out a loan or using credit (which can put you further behind on your financial goals).
Emergency situations in life could include the loss a job or livelihood, death of an earning family member, a health emergency or any natural calamity. With an emergency fund in place, you won’t go broke or fall into unnecessary debt with this cushion.
An unexpected expense, while painful, is often inevitable. By having an account dedicated to covering these costs, you won’t have to go into debt or put other financial goals on hold when you need to rely on them. - You’ll have more financial freedom.
The more debt you have, the less freedom you have to make choices in your life. Even if you pay off all of your debt, you’ll eventually have to deal with other types of expenses that aren’t as straightforward. Having a savings account to cover these expenses allows you to make the choices you want in life without worrying about how to pay for it.
Step 1: Decide How much you'll save
The first thing you need to do when setting up an emergency fund is deciding how much you’ll save. Experts typically recommend that you save at least 3-6 months’ worth of expenses, but it really depends on your financial situation.
Many experts post COVID-19 suggest that an emergency fund can include 1 year worth of expenses.
For example, someone with dependents or a large mortgage might need more than 6 months’ worth of expenses in their fund. Meanwhile, someone who is single, childless, and has no major financial burdens would likely be okay with less. There’s no right or wrong amount; it’s all about what works best for you and your financial situation.
Step 2: Pick the right account
Once you’ve decided on the amount you’ll save, the next step is to decide where you want to keep your emergency fund savings. Ideally, you’ll want to put the money in a savings account that’s easy to access (but you can’t easily transfer it to your checking account). You’ll also want to find an account with a low (or no) minimum deposit.
Some common options for an emergency fund include a money market account, liquid mutual funds or a savings bond. Savings accounts generally offer low interest rates and don’t have any special features (like a built-in return on investment). Bonds, on the other hand, give you a fixed rate of return and require you to lock your money in for a certain period of time.
Step 3: Automate your savings
If you’re having a hard time saving a consistent amount each month, you may want to try automating your savings. Using the MoneyPlanned app, you can link your checking account and have a portion of each transaction be automatically transferred to your emergency fund. There are many other apps and tools that can help you save money automatically.
You can set up an automatic savings plan with tools like Digit or Level Money. Or you can set up a recurring transfer from your checking to your savings account. Whatever method you choose, the key is to make sure that the money is getting transferred from your checking to your savings account on a regular basis. That way, you don’t even have to think about saving the money—it just happens.
Finally, it’s important to remember that an emergency fund is not meant to fund all of your financial goals. You should still have other savings accounts for other financial goals, like saving for retirement or paying off debt. An emergency fund is there to protect you and make sure you have the funds you need to pay for unplanned expenses without having to go deeper into debt.
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