Why emergency fund is important than investing?
I used to give a little thought to the emergency fund. Never consider having an emergency fund is important. I was confident that nothing would strike me.
I always focused on investing and growing wealth. Who cares to have an emergency fund? Such a boring thing to do. Not as exciting or thrilling as researching stock and investing.
That was my attitude toward an emergency fund till Dec 2019. Yeah, it is COVID 19.
Pandemic gave many lessons. One among them is the importance of creating an emergency fund.
Why emergency fund is important?
An emergency fund is a safety net fund created to aid a person in times of emergencies like loss of Job, hospitalization treatment, etc.
In such times, having funds in a liquid account can make a whole world of difference. An emergency crisis comes into our lives when it is least expected. So, it’s better to be prepared than regret.
You will be either happy about creating an emergency fund or regret not having one.
Cost of not having an emergency fund:
Failing to have an emergency fund could lead you to have a high-stress level & make unhealthy decisions when circumstances are not in your favor.
Selling existing investment: All your dear investment has to be sold due to a cash crunch. It will also have an effect on your investments which are meant to compound.
Debt: You will be forced to get into debt by taking money from friends, relatives, etc, many people take personal loans or credit card debt to meet their unforeseen expenses.
Peace of mind: An unfortunate situation takes away our peace from our lives. Having a backup fund keeps you calm and relaxed even when things go south.
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Benefits of emergency fund:
Makes long term goals achievable:
In recent times, people are flocking their investments to avenues like mutual funds, and equities. These are long-term investments to meet their financial goals, retirement savings, etc.
Having an emergency fund keeps you from breaking this investment & allows it to compound.
Sense of Security:
It gives security not only to you but also to your loved ones as well. Having funds in a liquid account to take care of the expenses for the next 4 to 6 months gives you a great feeling of accomplishment.
Your entire family feels secure because of your foresight & responsibility.
How much should you have as an emergency fund?
Many financial planners suggest that having three to six months of living expenses can be a good thumb rule.
But the pandemic taught as many lessons as possible, It lasted more than eighteen months. Many people lost their job, health, etc. So having a fund to take care of expenses for ten months to a year can be great.
Example: If your salary is 5000 USD per month. Your rent, utilities, grocery bills, tuition, gas, etc come to around 3500 per month. Then your living expense is 3500 USD per month.
So having 11000 dollars to 22000 dollars can be your safety net as suggested by the financial planner. Also trying to achieve a year’s living expenses doesn’t hurt though.
Where should you keep an emergency fund?
An emergency fund should be able to liquidate as quickly as possible.
Though it should be liquid, it is not something you have easy access to it. Parking a major chunk of the emergency fund on a liquid fund can help you earn a slightly high-interest rate and take a couple of days to liquidate.
Also part of the fund should be as cash & the remaining amount in a bank savings account.
Example: Let us say you accumulate a fund of 10000 USD/ INR.
2000 can be as cash in the house. Another 2000 on a bank savings account.
The remaining 6000 USD/ INR is on a liquid fund.
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What should you not do with Emergency Fund?
Having a surplus of cash can be nice. At the same time, you need to be careful about our itching to spend.
An emergency fund has a purpose. It is to take care of your living expense during unemployment till you find a replacement job or adverse health conditions till you recover.
It is strictly not to fund your home down payment, take a vacation, buy a new car, anniversary gifts to impress your spouse, latest gadgets, etc (list can go on & on).
Park your money in an account where you don’t have a debit card or net banking to access it. In this way, you can hold yourself from blowing it away.
Our mind can go wanky and say things like “YOLO” (You only live once). So you deserve to spend etc.
Don’t get deceived by your emotions and mind. It’s good to be ruthless with your own self in this matter.
Why Emergency Fund Over Investing is important?
Many people start to invest without a goal or clear mindset.
When you change your mindset, you will realize how important to have an emergency fund. Many people are forced to break their investments in emergency needs. These acts hamper their financial dreams & power of compounding.
When you have an emergency fund, there is no need to touch your mutual funds, equity savings, etc.
Once the emergency fund is accumulated, you can focus on your investment goals.
How to start it?
Setting aside a small amount of money can be a great step if you haven’t started an emergency fund.
Money as little as 5 percent of your income set aside in a disciplined manner every month can make a big difference.
Before you invest, transfer money to your emergency fund account.
The goal is to start initially. Once you get momentum, you can top up ten percent every quarter, six months once. This step will put you on a fast track to achieving your emergency fund goal.
An emergency fund can make a volume of difference during a crisis and help you stay prepared for any financial setbacks. You will thank yourself for creating an emergency fund.
Also, you should view this fund as an insurance policy where you pay yourself instead of an insurance company. It is not a fund to gratify your desires but to act as a savior in times of crisis.
As your paycheck increases and new members are added to your family, keep in your mind to increase the amount to match the new scenario.
If you have any suggestions or views, please let me know in the comment section.
Thanks for reading! Happy investing!