Emergency Funds - A safety net for your life.

What are emergency funds?

As the name suggests, emergency funds are a certain amount of money left idle, only to be used in case of any kind of emergency. It is also called a contingency fund or rainy day money in daily conversation.

It should cover any unforeseen event that can wreak havoc in your financial journey. Therefore, it is a corpus which you should use only in the case of any crisis.

Why do you need emergency funds?

Firstly, Emergency funds help you steer away from the burden of loans and taking on debt. Emergency funds ensure you do not take on more credit card debt or short-term loans, both of which are extremely expensive due to the high-interest rates charged. When you are anyway in a tight situation scrambling to pay for your expenses, each element of debt's principal and interest pricks you.

It eats away not only your savings and your income but also sucks a part of your soul. As they always say, debt entraps you. It binds your future trajectory. Each dollar of debt means that someone owns your time.

Secondly, they don't let your investments get derailed from their compounding. Emergency funds ensure that you don't have to part with your investment corpus for immediate needs. Each roadblock in your investing journey slows down your investments compounding effect.

For example, let's say you invested 10000$ three years ago. This money has been compounding at a healthy rate of 10% p.a. Now, let's say this year you got an unexpected expense to the tune of 3000$ dollars.

Let's look at the tables and charts below to understand the impact of withdrawal (emergency expense on your investment corpus.

Investment Corpus = 10000 $

Investment Rate of Return = 10% per year

Year	Interest Rate (%)	Earnings ($)	Final Amount
Year 1	10	1000	11000
Year 2	10	1100	12100
Year 3	10	1210	13310
Year 4	10	1331	14641
Year 5	10	1464.1	16105.1

Now, assume you had to stop this compounding in year three by removing 3000$ for an emergency expense.

Year	Interest Rate (10%)	Earnings ($)	Final Amount
Year 1	10%	1000	$11000
Year 2	10%	1100	12100
Year 3	10%	1210	13310
Year 4	10%	1331	11641
Year 5	10%	1464.1	12805.1

Your corpus would look something like this.

An emergency fund ensures that there is no break in the compounding efforts of your investments and lets you achieve your investment goals.

Most importantly, it helps you remain afloat and sleep better even when things turn for the worse. Emergency funds would ensure that you would never be tensed in case of a financial emergency, no matter what. You will always have the cash to deploy for any crisis quickly.

How much should I save for my emergency funds?

Experts recommend that you should have 3-6 months' worth of expenses, but I'd say it is always better to have a year's worth of expenses. This ensures that even if multiple emergencies arise, you might still be able to swim through them without any trouble. A healthy corpus of a year's worth of expenses ensures your expenses and any other foreseen events are taken care of.

How should I save for my Emergency Funds?

Experts say you should build a goal and save for this monthly, but I respectfully disagree. I believe emergency funds should be the first investment you make. Save for emergency funds first so that you can take higher risks with your assets and let them compound without needing funds for your immediate or short-term needs.

Ideally, you should invest every dollar after expenses and EMI's from the day you start saving. Every dollar saved for your emergency fund is another hour of good quality sleep, a peaceful mind, and higher control over your time.

As you inch closer to your emergency fund corpus, you can then start looking up other investment options. Then depending upon your life goals, start saving a part of that same monthly emergency fund savings in other investment vehicles. This will ensure that your great habit of saving and investing is continued.

As expenses and lifestyle keep increasing each year, it is pertinent that you keep adding funds each year to your emergency fund corpus. I have a simple rule, add a month's expenses every 2 years.

At the same time, don't forget to treat yourself. Once in a while, it is important to blow off some steam and have a good time.

When should I use my Emergency Funds?

An easy way to think about when you should be using your emergency funds is to ask yourself this question - "Will my daily life be affected if I don't make this expense?"

Simply put, does this expense make such a big difference that your day-to-day affairs and expenses are put on hold? If yes, use the emergency fund.

Some of the core reasons for using emergency funds are -

1. Job Loss

2. Any sudden medical expenses.

3. Replacement or repairs of essential appliances

   
   

Where should I keep my emergency funds?

Any financial instrument that ticks these 3 factors is a good place to keep your emergency fund

1. Highly liquid - You should be able to withdraw your money in less than 60 mins.

2. You never lose your invested capital - Remember, emergency fund capital is to be saved for your expense. Therefore, do not invest in any risky investment where there is a chance to lose your capital/investment corpus.

3. Matches your inflation rate - Your emergency fund should be parked in any investment vehicle which matches your country's inflation rate.

Ideally, high-yield savings accounts are a great place to start saving and investing for emergency funds.

Even the best ships have lifeboats. Even the best planes have parachutes. You cannot anticipate events, but you can always prepare for them.

Events like a job loss, a medical emergency, or a natural calamity can cause severe mental and emotional turmoil.

A good emergency fund acts as a safety net. It reduces the impact of such events in your day-to-day life drastically. It helps you sleep peacefully and not let your emergencies bother your daily life.