A Guide to Building an Emergency Fund!

a guide to building an emergency Fund

Tune Mera Golden Chashma Becha! Raju…

We all remember this hilarious scene from the movie Phir Hera Pheri, where Raju sells Babu Bhaiya’s golden Chashma because of an unforeseen financial issue.

If you remember, at the movie’s beginning, Babu Bhaiya lived a lavish life. Just name it, and he had it all. A big house, a car, a private swimming pool and what not! 

While living a lavish lifestyle, the last thing he could think of was building an Emergency Fund. Little did he know that just building an emergency fund could save his golden chasma from being sold!

His character is the perfect example of how most of us live our lives these days. We enjoy the moment without thinking about what will happen in the future. But building an emergency fund is a must!

What is an Emergency Fund?

An emergency fund is nothing but a rainy day fund. It is a fund you keep aside for unexpected events in life. And hence this money should be kept in an asset class which is liquid or could be easily converted into cash. 

Before an uncertain situation smashes through your window, you need to start collecting an emergency fund. 

How to Start an Emergency Fund?

Solution 1: When you receive your salary, the first thing we all do is create a budget. We note down our spending targets. For example, Rs 12,000 for groceries, Rs 4,000 for fuel, etc.

If you carefully analyse, you are first thinking about how much you would spend rather than how much you would save. 

So, if we were to summarise this situation in a formula, then it would be:

Saving = Income – Expenditure

Now, let’s look at the formula differently.

Expenditure = Income – Saving

You will save a fixed amount from your salary every month before spending.

Solution 2: Build an emergency fund using the 50-30-20 budgeting rule.

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You must spend 50% of your income on your needs, 30% on your wants, and save the remaining 20%. 

To create an emergency fund, you can invest 20% of your income until you reach your savings target. 

How Much Emergency Fund Should You Keep Aside?

Generally, it is recommended that you must keep an emergency fund that will cover you for the next six months. So, if your monthly expenditure is Rs 30,000, your target emergency fund corpus would be Rs 1,80,000. 

Where Should You Keep Your Emergency Fund?

As discussed earlier, you should invest your emergency fund in an asset class which is liquid or could be easily converted into cash. 

Does the highest liquidity mean a saving account? Is this what you are thinking right now?

Yes, you can keep a small corpus (30%) of your emergency fund in your savings bank account, which you can access during a sudden uncertainty. The focus of keeping this corpus would be easy accessibility than returns. 

As of June 2022, India’s retail inflation numbers have touched a record high of 7.01%. The value of your money will diminish faster. So, our focus should be that the remaining 70% corpus should earn returns close to the current inflation rate. But remember, the focus of investing this corpus would be to earn fairly higher yet safe returns, capital preservation, and easy liquidity.

Which Are the Investment Options That Fall Under This Category?

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We never know what’s going to happen in the future. So, don’t be a Babu Bhaiya! Be a smart financial planner and build an emergency fund so you won’t regret it.

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