If you had a crystal ball to look into the future, perhaps you could see all the difficult situations you will have to meet and you could plan your finances accordingly. But since that’s not the case, you need to have an emergency fund for such situations.
An emergency fund is money specifically earmarked to meet unexpected situations which can negatively impact your financial position like loss of job, illness etc.
How an emergency fund helps you in an unexpected situation?
1) It helps you meet your immediate requirement of funds.
While it may or may not suffice the complete expenditure, an emergency fund provides you a financial buffer. It also gives you time to take steps to meet the situation.
eg. If you loose your job without any notice, it can help you meet your day-to-day expenses till you get another job or figure out what to do.
2) It prevents your financial situation from worsening further.
If you don’t have an emergency fund, then you may be forced to borrow money at a high interest rate eg. by maxing out your credit card, personal loan etc. This will put additional pressure on your finances in an already difficult situation.
3) It protects your investments and saves you from incurring losses due to breaking your investments.
Whenever you invest, you keep a certain time frame and risk factors in mind.
Suppose you invested in stock market with a long-term horizon. If you don’t have an emergency fund , then you may have to take out your money when the present value of your investment is less than what you had invested. This way you would incur a loss and also miss out on a long term opportunity. This can upset your entire financial planning.
Points to remember:
1) Do not confuse an emergency fund with your other investments and insurance.
It is in addition to other investments/insurance and earmarked for a specific purpose.
eg. If you don’t have an emergency fund and use your investments to purchase a house, then your safety net will vanish.
2) Use your emergency fund only in case of ‘real’ emergencies.
Often, if you have money stashed aside, it is tempting to dip into it for any additional expenses.
Make sure you don’t use it everytime you fall short of money. The very purpose of creating an emergency fund gets defeated in such a case.
3) Make sure that the fund is easily accessible.
If you have created a fund but are not able to access it in case of emergencies then it is of no use. Make sure that you have easy access to it. Eg if you keep it in a savings account, then you can withdraw it using an atm anytime you need.
4) Do not put your emergency fund in risky options.
Suppose you create an emergency fund of Rs. One lakh but invest it in stock market. Due to the uncertainties associated with stock market, it is possible that at the time of your need, the market value of your investment could be less than Rs. One lakh.
Remember: The purpose of emergency fund is to create a safety net and not to make maximum profit out of it.
5) If you use your emergency fund, make sure to replenish it.
If you dip into your emergency fund to meet a situation, remember to replenish it at the earliest possible time. This way your safety net will continue to remain in place.
The way ahead
Remember, when faced with a difficult situation, you will still have to arrange for funds and meet your expenses. However, money crunch will make an already difficult situation, more difficult. Why not prepare for such things when you can and have peace of mind with a safety net in place?
So, if you don’t have an emergency fund as yet, start creating it right away!
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