Imagine standing on a cliff-top. Beautiful, isn’t it?
Suddenly your feet topple and you fall into the dark and deep valley. As you keep falling, you close your eyes thinking that this would be the end of you. Suddenly something happens that saves your impending exodus from the planet earth. A parachute attached to your back unfolds. Needless to say, you reach the ground safely.
What would you call the life-saver parachute?
I named it ‘The Emergency Fund’!
What is an emergency fund?
An emergency fund is the amount of money that helps you manage certain financial exigencies when no alternative financial support system is in place to fall back on. The art of savings and maintaining an emergency fund requires meticulous yet flawless itinerary and farsightedness. This, in turn, can be steered to generate potential savings and return on investment by intelligently and efficiently channelizing your income into the minimum expense and maximum investment opportunities.
Where will emergency fund come from?
During our growing age, we are attracted to the luxuries of life. Although, that is the right age to start saving. Instead, we follow the economic principle of ‘keeping up with the Joneses’. What we see around becomes a benchmark for us to maintain the social class and status. If my neighbor buys a car, we buy a car too, possibly a bigger one!
During the 20s and 30s, new gadgets, clothes, and other luxuries are our priorities. You can indulge in the latest mobile upgrade to flaunt in front of your colleagues, or a Nike shoe to show off in front of your girlfriend. At least, buy a Gucci Bag to show my neighbors how better off are you financially.
We forget that we need to have a financial plan to fall back on. We cannot afford to get financial jerks because of unplanned spending and planning comes from financial literacy. You need to go through meticulous planning and a bit of sacrifice to create emergency funds. While luxuries and short-lived, savings is eternal. Savings in the form of an emergency fund will always stay with you if you take good care of it. They will withstand your distress and despair. Luxuries will hop out of the window if it feels you are in financial trouble.
A few things can help create the fund for you:
- Windfall gains need not be spend on luxuries; it should be kept aside as an emergency fund
- Additional income in the form of a pay rise, tax savings, or bonus/incentives can add up to the emergency fund
- Defer buying of high-value products as much as possible
- Don’t try to keep up with the Joneses
- Have your feet on the ground when it comes to spending money
- Remove wheels from the money when it goes into your wallet
- Avoid Credit cards. Or taking high-value loans or borrow money
All the above can help you mitigate your financial woes if adhered to.
How much money should you have in your emergency fund?
As we grow in age we need more money as our responsibilities increase. Ideally, you should have 2-3 times your gross monthly income if you are alone.
We get married and have children. We start living and earning for our children’s wellbeing. We need to take care of the health of our beloved children, offering them a congenial environment to grow and develop.
Our children and family are our greatest responsibility and also the cause of financial stress. Our children grow up fast and we need to take care of their educational expenses from enrolling them to a good school up to their graduation and maybe beyond if they want to enroll in professional courses, and that’s a lot of money. So, we need to display adequate financial preparedness to manage expenditures at very short notice. It takes a lot of sacrifice on our end to build an emergency fund.
Inferring from the above scenario, if you are married and have grown children, then it is advisable to keep 6 times your income in the emergency fund.
How to create an emergency fund from minimum wages?
We understand that not all of us get a 6-figure pay package. Many live at the subsistence level or on a minimum wage. We can very well create an emergency fund. We must have the support of an emergency fund if we are on minimum wages.
Let’s understand the need to create an emergency pool of funds on a low income. This becomes even more relevant when you are surviving on minimum wage.
Most developed countries in the world offer the assurance of minimum wages. It further helps the bread-earners to promote savings in the family to create an emergency pool of funds after meeting the expenditures.
This circles back to the question “How much do I Earn?” An emergency fund is a dire necessity if you are surviving on minimum wages. Let’s have a quick review of the emergency fund in light of the distribution of minimum wages around the world. The need for an emergency fund for minimum wage goes hand in gloves.
Minimum wages in developed and developing Countries
Considering low minimum wage levels in developed as well as developing countries like India as depicted in the figure below, you will realize how important to have emergency funds support.
A startling reality unleashed while attempting to compare the stipulated minimum wages of developed countries with that of the developing ones, India in particular. The table below depicts the observation.
|Nominal (US $)||PPP Int($)||Nominal (US $)||PPP Int($)|
**PPP – Purchasing Power Parity
While the minimum hourly wages of Canada, America, and the UK are $8.71, $7.25, and $11.63 respectively, developing countries like India is only $0.31.
This shows that allocating funds for an emergency is a daunting task fund in developing countries where the minimum wage is too low as compared to the USA or other developed countries.
In developed countries like the USA, emergency Fund is indeed a potent tool to support a decent and dignified living and saving goals of a family.
Of late, promoting savings and creating emergency fund creation is gaining priority among wage earners in the developing countries too.
What the emergency fund is used for?
There is no denying that the emergency fund is your ‘Safety Net’ during the rainy days. An emergency fund is a friend in need. It brings you out unscathed from financial dire straits and helps you stay afloat even during the darkest days of life.
You may wonder what could be some emergency expenses that we need to incur.
Here are a few advantages favoring the need for having an emergency fund amount in your kitty:
- Financial empowerment with safety, growth, and liquidity
- Helps you meet financial obligations and preserve your way of life
- Your shield to Financial Debacles due to family medical emergencies, disability, and medical illness
- emergency fund protects you from market volatility
- Protects you from economic turbulence and swinging economic conditions
- Reduce the economic challenges and financial fallouts posed by job loss, Lower GDP growth rate, and adverse government policy changes, Pandemic, Natural Calamity, among others
- Help you and your family stay afloat during uncertain times
- Boost self-confidence and lets you get going even in the most damaging financial conditions
- Last but least, help stay out of debt
Where should I keep my emergency fund?
Saving money and keeping it at home is not a smart idea. The first thing that you need to do is to remove the wheels from the emergency fund. You need to learn to forget that even such fund exists in your life and just keep putting money into it in a disciplined manner.
Of course, a myriad of market-driven ‘safe’ investment instruments let you build a strong base of emergency funds, synchronously offering the power of compounding.
I call emergency fund ‘The Untouchable’. Once you set aside a certain amount into these funds, you should forget about them. Switch on the inherent auto-renewal facility, so that the return on investment (ROI) is reinvested on maturity to reap the benefit of compounding.
We will address this issue on where to put your emergency fund in a bit. Let’s address the amount of money that you need to have in an emergency fund.
Albeit, the related question, how much to put in the emergency fund, is a tricky one, I would like to look at it from a different perspective. I would rather see how much I can save without squeezing my bare-minimum expenses further. Is a $1000 emergency fund enough? Yes if that is all you can set aside for emergency fund, however, there is no cap.
Ideally, three months of your living expenses must be maintained in your emergency pool of funds and 6 months’ expenses, if having dependents, as an emergency fund would help.
We will further help you with options on where to put the emergency fund and what should my emergency fund look like.
We are not talking about emergency fund vs. savings, rather, emergency fund and savings.
We will explain the Average Percentage Yield on your investment and how you can reap the benefit of the power of compounding to fatten the emergency fund.
Please note that the below figures are arrived at leveraging online emergency fund calculators that even you can access to vet the numbers.
What is an emergency savings fund?
Now that we know about the emergency fund, let’s understand what an Emergency Savings Fund is. Emergency Savings Fund is where you save your money for your financial emergency and earn APY too. I am talking about your Bank savings account. It is advisable to keep money in the Bank rather than at home. This way, you can earn APY on your idle money and make use of the liquidity feature to meet emergency expenses.
Here is how you can create the emergency fund with your savings account. Certificate of Deposit is one way to keep your emergency fund in and let it grow.
Certificate of deposit
CD enabled emergency fund building mechanism is based on how much you can comfortably set aside. CD allows you to withdraw funds without attracting penalties.
Considering an Annual Percentage Yield (APY) of 1%, below is what you get over a period of 5 years to build your Emergency Fund by depositing $1000 up to $5000.
|Deposit in $||Total Balance in $|
Assuming your income of $2500, the thumb rule says that you should have at least twice your monthly income, which is $5000 in this case, in the emergency fund. As the figure above displays, $5052 ensures your posturing to keep $5000 in the emergency fund.
If you do not have a one-time $5000 to deposit, make it a monthly recurring deposit of $1000 to create the emergency fund in 5 months and then maintain it that way or add to it as and when possible.
Especially in developing countries like India and Southeast Asia, maintaining an emergency fund in India has become a common practice due to the looming economic and political uncertainty.
In a nutshell, the emergency fund lets you live our life with head held high. It goes a long way to save you from financial humiliation. Peace of mind is necessary to live a wholesome life and the existence of an emergency fund is imperative.
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