Here’s why emergency fund matters

Every investor aims to increase their financial preparedness while making investment-related decisions. Maintaining an emergency fund is one of the most valuable tools for achieving this objective. An emergency fund serves as a financial safety net, providing peace of mind and security in times of unexpected crisis. Liquid mutual funds have become reliable for maintaining and growing emergency funds. This article shall explore the significance of an emergency fund for investors and explain why it matters.

What are emergency funds, and what is their function?

An emergency fund is a dedicated fund that covers unforeseen expenses or financial emergencies. These emergencies could range from medical bills and sudden job loss to unexpected home repairs or car breakdowns. The primary function of an emergency fund is to ensure that individuals have a financial cushion to fall back on when life takes an unexpected turn.

  • Example: If an investor loses their job unexpectedly and is unsure about their next source of income, they might find it very difficult to continue to pay their bills and meet other essential expenses. An emergency fund can help an investor in this scenario.

Financial experts recommend having an emergency fund covering at least three to six months’ living expenses. This fund provides a significant buffer to weather the storm of financial uncertainty. Without an emergency fund, individuals may have to rely on credit cards, loans, or even liquidating investments at inopportune times, all of which can have long-term financial consequences.

Why does an emergency fund matter?

  1. Emergency funds can help weather a health emergency:
    The COVID-19 pandemic that swept across India and the world underscored the importance of having a robust emergency fund. Those with well-funded emergency funds were better equipped to manage their finances and navigate the uncertain times without incurring substantial debt.
  2. Investors can use their emergency funds to cater to immediate cash requirements
    Cash requirements on events such as an unforeseen car repair or a last-minute travel expense can be met using an emergency fund.
  3. Emergency funds earn moderate returns at a lower risk
    Many investors choose to park their emergency funds in relatively low-risk investment options like index funds. These funds offer the potential for modest returns while still allowing quick access to cash when needed.
  4. Emergency funds offer instant access to cash
    Emergency funds provide instant access to cash. There’s no waiting period or penalty for withdrawal, ensuring that individuals can swiftly respond to financial emergencies without delay.

How to estimate the size of one’s emergency fund?

Calculating the size of your emergency fund is a crucial step in financial planning. Here’s a simple method to determine the right amount:

1. Calculating monthly expenses:

Investors must calculate their essential monthly expenses, including rent or mortgage, utilities, groceries, transportation, insurance premiums, and debt repayments.

2. Estimating the value of one’s emergency fund:

Investors must aim to accumulate enough funds to cover at least three to six months’ worth of these expenses.

In an unpredictable world, an emergency fund is the financial shield that can protect you from the unexpected. Investors must remember that everyone’s financial situation is unique, so their emergency fund size may differ from someone else’s. Investors must regularly review and adjust their emergency funds as their financial circumstances evolve.