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How to build and maintain an emergency fund

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On an average, every individual faces at least three emergencies during their life time. These emergencies could range from a job loss to a health scare. It is important to make sure that money is the last thing to worry about during such stressful times.

Building an emergency fund is the primary step to avoid any financial disaster because of any unforeseen or unfortunate events in life and prevents professionals to spiral into financial distress during difficult times. Majority of personal finance experts advocate maintenance of an emergency fund that accounts for 3-6 months of expenses.
 
Emergency fund should be held in assets, which guarantee capital preservation and can be converted to cash quickly. It also reduces dependency on loans or liquidation of other assets.
 
The steps mentioned below help in building and maintaining a healthy emergency fund.
  • List your regular monthly expenses: The first step to building an emergency is listing down all your monthly expenses ranging from household to loans. Identify the expenses which are compulsory and which are not. This helps in determining the optimal emergency fund required. Considering unnecessary expenses will result in abnormal or wrong calculation of emergency fund requirements.
  • Assess your income streams: The next step is to analyze all your income streams. This is especially important for small time vendors and business men who have more than one income stream. Even while listing down your income streams, distinguish those which give you continuous funds and those that don't.
  • Know the monthly savings: Once you do the basic budgeting, you can exactly assess the monthly savings you are making. Check whether the current savings rate is good enough or not.
  • Try to improve your savings: There is always room for improvement when it comes to savings. Improving savings should be a continuous process. Find out the areas where you are spending more and assess whether you can cut down your spending in these areas.
  • Start small: Don't try to make all the savings required to build an emergency fund in one month. This can prove to be a burden. Start with smaller amounts. Make sure you set some money aside every month as a part of your emergency fund until you reach the optimal level.
  • Reduce an expense: Find that one expense which you can cut back on. For example, if you have tea thrice in a day, try to make it one or two; if you eat out daily, see if you can pack a lunch box to office. Though you think it is just Rs 10-30 extra per day, by cutting on down on them you can save nearly Rs 300-900 a month. This money can be used to boost your emergency fund.
  • Pick the place where you want to put your emergency fund: Once you decide on saving money for emergency fund, pick the right place to save your money. Ideally, emergency funds should be easily accessible and easy to withdraw. It should be maintained in cash or cash equivalent form. If you are starting in small amounts, savings bank accounts which give high interest rates is a good place. You can keep on depositing money on a monthly basis and earn interest on the amount being saved. Once you have substantial savings or if you are willing to invest in higher amounts, liquid funds is the place to park your emergency fund. Money market funds have been performing good and providing good returns.
  • Remember emergency fund is only for emergencies: The best way to maintain a healthy emergency fund is not to touch it until you have an emergency. Don't withdraw cash from your emergency account to fund your unnecessary expenses or for buying something which you like.
  • Monitor and Assess: Monitor your budgets and make sure that your emergency fund is always at the optimal levels. Whenever there is a change in your financial situation make sure you revisit your emergency fund requirements and make the required changes. This helps in maintaining a healthy fund to counter unnecessary debts during emergencies.

Nitin Vyakaranam is the founder and chief executive officer, ArthaYantra, an integrated online personal finance company.

Disclaimer: The opinions expressed in this article are the personal opinions of the author. NDTV Profit is not responsible for the accuracy, completeness, suitability, or validity of any information on this article.

Story first published on: April 09, 2013 17:30 (IST)

Tags: Emergency funds, Savings, Personal Finance, Investment tips


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