What is Emergency Funds: Meaning, Significance, Types and Benefits

Effective financial planning involves preparing for unexpected situations and protecting future assets and resources. An individual’s assets and life may be insured, but the constraints of insurance plans lead to numerous emergency scenarios not being covered. During such difficult circumstances, emergency funds aid in getting through them with relative ease. Therefore, this blog discusses various aspects of emergency funds meaning, significance, types, benefits, and more.

Emergency funds are monetary reserves secured aside in liquid assets to be used during unanticipated financial turmoil or unforeseen difficulties. These may include but are not limited to income or employment loss, substantial repairs to houses or vehicles, medical expenditures, etc.

Financial and lending institutions do not offer any sort of emergency fund accounts. Hence, setting up such an account and building the funds are solely the responsibility of the investor.

One must be prepared for all the unanticipated events that may occur throughout life. Here are a few reasons why people should invest in an emergency corpus while planning for a financially secure life:

• Helps Avoid Debt Traps: People can remain afloat during challenging financial struggles by not taking on loans or credit card debts and instead utilising their emergency corpus. Therefore, such emergency reserves protect individuals from falling into debt traps during financial crises.
• Safeguards Future Assets and Savings: An individual's funds are tied to several crucial long-term objectives. Emergency funds assist people in achieving their long-term goals by satisfying their immediate needs without depleting their savings and long-term assets.

One has to build an emergency fund gradually. It is not something that happens overnight. Based on one's income and expense ratio, this fund can be anywhere from 3 to 6 months of the individual's monthly wage. People should save a certain amount of revenue each month, put it into a separate bank account and allow it to develop into a significant corpus.

Let’s better understand this with these 2 examples:

• An individual earning Rs.20,000 per month and spending Rs.10,000 on living expenditures should have an emergency fund of around Rs.40,000 to Rs.80,000.
•  Assume a person wants to store Rs.80,000 for an emergency fund. Then the individual must set aside Rs.4,000 to Rs.8,000 a month to develop the required capital.

Here are some measures one can take to create an emergency fund:

1. Establish a Monthly Savings Target

Having a monthly savings target helps inculcate the habit of regular saving. Thus, it makes building an emergency corpus more manageable. Investing in a SIP is an excellent method to accomplish this.

2. Determine the Total Required Corpus

Calculate how sizeable the emergency corpus needs to be to meet all living expenses for the upcoming six months.

3. Calculate Monthly Expenditures

Plan out monthly expenses and spend as low as possible to save enough for an emergency fund.

4. Evaluate and Adjust Contributions

Check the corpus periodically to see how much has been saved and make alterations to the contribution quantum as needed.

There are two different types of emergency funds:

• Short-Term Emergency Funds: These funds help during immediate financial needs or emergencies. Such funds have low-interest rates but offer instant accessibility and liquidity until one can access the long-term emergency corpus.
• Long-Term Emergency Funds: The funds are reserved for large-scale crises, such as a severe natural catastrophe or unforeseen medical expenses. Individuals should invest their assets in financial products that offer better interest rates at the cost of requiring a few days to liquidate.

Here are a few benefits of having an emergency corpus in place:

• Promotes Healthy Saving Habits: Creating an emergency corpus encourages people to save more money and lowers the habit of leisure spending.
• Helps Reduce Overall Stress Levels: People can lead a stress-free and peaceful life if they have an emergency fund. This is because individuals know that they have a backup strategy if and when things go wrong.

Building an emergency fund to cover all unanticipated costs in the near future is the first step to good financial strategy, planning, and investing. While this may seem excessive, an emergency fund may make all the difference during an unfortunate, unanticipated crisis. Now that you know more about the aspects of emergency funds meaning, significance, types and more, you should safeguard them and treat them like your personal insurance policy.