We all have big dreams, don't we? Whether it's about owning a home and car someday, travelling abroad for vacation or kick starting our own business, dreams have no limits. Nor should they. However, irrespective of how different our dreams are, one thing that remains the key for everyone to turn our dreams into reality, is a rock solid financial foundation. No matter what career you are into, how big your bank balance is, what your monthly expenses you have or what your spending habits and lifestyle preferences are, one financial asset that can be your forever best friend, especially on your rainy days, is an emergency fund. Wondering how? Read on to know what its role is and how it becomes the key to holding a strong grip over your finances in all seasons!
Emergency fund, also termed as a contingency fund, is a a part of your savings separately kept aside to tackle unforeseen financial exigencies of life, which are capable of temporarily hindering your regular inflow of funds. The exigency can strike anytime and in any form, whether as a sudden job loss, severe illness, disability, pay cut etc. In all such adverse life events, having an emergency fund can help you carry on with your regular expenses.
Emergencies are an undeniable truth of life. So why not prepare for it with the help of an emergency fund, rather than waiting for it to come and cause the damage that was otherwise preventable. After all 'prevention is better than cure¡¯!
Let¡¯s take an example to further make you understand the importance of an emergency fund. Ever seen an under construction building? Of course you must have. But have you ever wondered what would happen to that building if its foundation turns out to be weak? The building is likely to collapse someday, especially in case of adverse calamity like an earthquake.
Now imagine having a 'no' or 'weak' foundation for your finances. A single financial exigency can cause a turbulence in your financial life, and even wipe out your lifelong savings. Sounds dreadful, right?
This is exactly where having an adequate emergency fund comes to your rescue. Emergency fund provides the absolutely necessary solid foundation for your financial health, and becomes your helping hand during rainy days of life. So, irrespective of your income, job profile, bank balance etc, your first priority as soon as you begin earning, should be to create an adequate emergency fund to fall back upon when the need arises.
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There is no hard and fast rule here. The bigger the better. But ideally, to begin with, your emergency fund¡¯s size should at least amount to 6 to 9 times your recurring monthly expenses, such as house rent, SIPs, utility bills, insurance premium, children¡¯s tuition fees, and loan EMIs. And thanks to the huge wake up call that the pandemic has served up as and shown how not just you but the entire world can suddenly come to a standstill, it becomes even more imperative to realise the importance of an emergency fund, and how this separately kept kitty can be your saviour whenever life¡¯s financial exigencies strike. Surely, those who had maintained an adequate emergency fund would have been better positioned to tackle the financial ups and downs during the pandemic. Also, when you create and maintain this emergency fund, remember to ensure that this fund¡¯s amount should proportionately be increased whenever your expenses rise in the future, otherwise the fund can turn out to be insufficient if it¡¯s size is not increased in proportion to your recurring expenses.
Both absence and inadequacy of emergency fund can land you into not one but two pitfalls. Let's understand the first one. If you are amongst those who ignore the importance of emergency fund under the misconception that your investments would bail you out when required, then stop and read this. Redeeming your investments can have two consequences. Firstly, as most investments are done towards reaching a specific financial goal, like accumulating down payment for house or child¡¯s higher education corpus, relying on your earmarked investments to meet financial shortfalls during exigencies can lead to failure to achieve those set financial goals. Secondly, if the investments that you rely upon are market-linked, like mutual funds, you are in for more trouble in case you end up having to redeem them when your portfolio is already bleeding red, like in case of market crashes. So, if the exigency happens to strike during such bearish market phases, you are likely to incur losses on your hard-earned money that was put as investment, just because you chose to turn a blind eye towards the importance of an adequate rainy day fund.
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Now, the second pitfall is in the form of pushing you towards the awkward and embarrassing situation of borrowing from others, like friends, family or colleagues. You may even have to resort to approaching financial institutions like banks, NBFCs etc for availing loans to fulfil financial shortfalls. And even that's no easy way out, as lenders tread cautiously when giving out loans, especially to someone whose repayment capacity they are unsure of, like in case of financial exigencies such as job loss or severe illness, which hinder your regular inflow of income.
And besides all this, even if you have sufficient savings or big bank balance, it's always advisable to keep the adequate amount kept aside in the form of an emergency fund, which remains untouched and undisturbed until and unless a financial exigency arrives. This way, not only do you remain better prepared to tackle life's exigencies, especially the ones that hinder your regular inflow of income temporarily, but you also get to enjoy peace of mind, knowing that you have a sufficient cushion to fall back on if any unforeseen exigency arises someday!?
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