What is an emergency fund? - Meaning, importance & steps to build

An emergency fund is your financial safety net. This money is placed aside for life's unexpected expenditures. Imagine your car breaks down unexpectedly, or you suddenly need medical treatment, or you lost your job without any warning. These unplanned and sudden expenses can be met easily if you have an emergency fund in place. Let us understand the meaning of an emergency fund, how it lets you manage unexpected costs without worry or debt.

What is an emergency fund?

It is a corpus to meet unexpected expense, which could be medical bills, automobile or housing repairs, and income loss. You may utilise the fund for any unforeseen expense that isn't within your regular budget. Having this safety net ensures peace of mind for yourself and your family members.

Why do I need an emergency fund? 

Research shows that people who can't bounce back from losses often don't have enough money to handle sudden problems. Having a lot of debt to repay may make it a challenge for you to meet your regular financial obligations. A monetary cushion, such as money set aside in a liquid asset, acts offers a reserve, serving as a strong barrier against financial difficulties.

How much do I need in an emergency fund? 

The amount you need to save for an emergency fund depends on your situation. It depends on factors such as your monthly expenses, loan repayments, the number of dependents in your family, and so on. Reviewing your outgoings and beginning with what you have might help you establish a buffer for uncertain times. 

How to build an emergency fund? 

Set a goal

When you start saving, an emergency fund should be the first priority. This is especially true for new savers. Use analytical tools, such as an emergency fund calculator, to find out how much you would need for your fund. There are such tools available online and are easy to use.

Create a system for making consistent contributions

There are many ways to manage money, but automatic transfers are the easiest and most practical. Set up a Systematic Investment Plan in a liquid Mutual Fund or a short-term Debt Mutual Fund from your Savings Account. Or set up a Recurring Deposit having one-year maturity. This will help you save money automatically and regularly. Plus, it will make you more disciplined about saving money, since you will be saving before spending.

Regularly monitor your progress

Regularly monitor your savings. Sign up for automatic balance alerts from your Mutual Fund and Savings Account. Watching your savings increase may motivate you to manage your money carefully and save more. 

Example of an emergency fund

An example will help explain the need for an emergency fund. Consider a family needs ₹ 1 lakh every month, for EMIs, and other regular expenses such as food, children’s school fees, utility bills, etc. They should create an emergency fund of at least ₹3 lakh following the 3-month rule. With an emergency fund in place, they may not need to borrow or change their lifestyle much in the case of an emergency expense.

Where should I keep the emergency fund?

Ideally, you should save money in an instrument that you can access easily whenever you need it. Following are some options you could consider:

• Savings Account: Because it's secure and accessible, setting aside the money for your emergency needs in a Savings Account is the most convenient option. Your money earns interest in the bank and is easy to withdraw whenever you need it.
• Liquid Funds: Liquid Mutual Funds invest the assets in debt and money market securities having duration of up to 3 months. Hence, they are safe from interest rate fluctuations and apt for setting aside the money you may need in a hurry. Liquid Funds offer slightly higher interest rates than with a Savings Account. 
• Short-Term Fixed Deposits (FDs): Short-term FDs provide a guaranteed return for a fixed period. Ideally, FDs with maturity of up to one-year can be considered for emergency needs. But do note that if you withdraw your FD before maturity, it may involve a penalty.

When should I use the emergency fund?

Below are examples of when to use your emergency fund: 

• Job Loss: You may utilise emergency funds for rent, mortgage, food, and expenses until you find new employment.
• Major medical expenses: Even if your health insurance plan may cover your hospitalisation expenses, other expenses such as out of hospital medical expenses, regular expenses in the case of a job loss, etc may prove to be a financial burden. This can be addressed effectively with an emergency fund.
• Urgent home / car repairs: Replacing a damaged car or leaky water pipe in your house may derail your well-planned monthly budget if you don’t set aside a corpus to deal with such exigencies.
• Unexpected travel: In an unexpected family emergency, you may need to travel immediately. An emergency reserve will ensure your trip is stress-free. 

Also Read: ETF vs Mutual Funds: Difference between ETFs and Mutual Funds

What is an emergency fund for? 

Remember, it's called an "emergency" fund for a reason. Avoid spending money on non-essentials or planned costs. Also, avoid using your emergency fund for unnecessary expenses like movies or impulse shopping light bills. An emergency can impact finances, but disciplined investing with Axis Bank can help secure your future.

Disclaimer: This article is for information purpose only. The views expressed in this article are personal and do not necessarily constitute the views of Axis Bank Ltd. and its employees. Axis Bank Ltd. and/or the author shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.

Mutual Fund investments are subject to market risk, read all scheme related documents carefully. Axis Bank Ltd is acting as an AMFI registered MF Distributor (ARN code: ARN-0019). Purchase of Mutual Funds by Axis Bank’s customer is purely voluntary and not linked to availment of any other facility from the Bank. T&C apply.