Emergency Funds: What are they & How much should you save?

Emergency funds are a much-needed cash asset in this day and age. While people have started getting into the habit of budgeting and stashing money away into their savings - when it comes to emergency situations, the bottom line is no one can predict them.

And even though people do understand its importance, the two most compelling factors of an emergency fund is that people usually don’t know how much they need in their emergency fund and on what parameters or by how much your emergency fund should grow.

To answer the two, in their most simplest terms, your emergency fund should, at the start, be enough to cover 3-6 months of your expenses and as your income grows and you see added responsibilities, you should also increase your contribution to your emergency fund, stretching it to cover upto a year worth of your expenses. And this should be a part of your financial planning.

As your income grows, you must be better prepared to be able to take care of your emergency situations. Which although seems like a no-brainer, but sadly isn’t the case.

Emergency funds are savings made in preparation for financial surprises that might arise without your slightest knowledge. From losing your job to fixing a broken car to medical issues - you should build your emergency funds to have your back.

Emergency funds should be started right from the time you get your first income. Saving 10-20% of your income should, ideally, be the rule of thumb here, for the first couple of years of your income. This is initially to get over the inertia of building a saving habit, as the saving psychology says, start small and it all adds up.

As humans, we’re hard-wired to always go for the present benefit of the money. And neglect how it could benefit in the future. And this is the same reason why even when we know that saving for retirement is important, we procrastinate it to an extent that it becomes meaningless to start a retirement fund, after a certain point of time.

When you think about emergency funds, you have to think of exponential growth, therefore, it is fair to say that by 30-35, you should've saved up at least a year's salary, in an emergency fund. So that, come what may, you’re well prepared to tackle the adverse situations.

But will that happen overnight? Or on the back of 5 years worth of saving? Or 10 years? Nope. Sadly, none of those.

Instilling this habit from the very early stages of your professional career is important, otherwise you won’t be able to meet that number. The other reason is as you progress in your professional career, your expenditure is only going to rise. And I’m not talking about the necessity of those expenses, but when you’ve a rising expenditure, it’s difficult to stash out money for “future use”.

Because of the easy availability, i.e., liquidity factor you need to ensure with your emergency funds, it’s also a good idea to put this money in liquid funds, if you’re someone well accustomed to investing. And you can take the help of several investment apps to ease out this process for you.

And there’s a reason why I specifically mentioned 30-35.

30-35 is the age group when you start having additional dependencies in life in the form of spouse and children, which increases the scope of emergency situations. On the other hand, it’s also safe to presume that by this time, you’ll be stable within your career and your salary graph will always show an upward trajectory.
Hence, by this time the money in your emergency funds should be large enough to accommodate these situations.

Now, in no way I’m saying that this is going to be an easy ride.

This could mean heavily cutting down on impulse purchases, or that holiday you've wanted to go on because you now have the money. I’m not telling you that you’ll have to kill all your aspirations. But as long as you don’t have a year worth of savings in your emergency fund, it’d, ideally, be good for you to cut down a little so as to be prepared for the rainy days.