Introduction
This article explains the importance of Emergency Fund and how to start accumulating it through a simple flow chart. This article mainly focusses on accumulating emergency fund through the expenses (Discretionary).
What ?
As the name indicates, emergency fund is useful for any emergency situations when your
- Regular income has stopped.
- Passive income has stopped.
- Savings is unable to meet your day to day expenses.
- Any Unforeseen circumstances
It is considered as a financial safety during any of the said circumstances. Helps you to meet (or) run your regular expenses. According to me, this should be considered as the first step before even thinking of any investing.
Why ?
Think about following scenarios:
- Due to COVID-19, few predictions that are going around internet says that there will be 195 million job losses. Isn’t this a panic situation ?
- Immediately you may need double the times of your salary but all the source of money has let you down. Isn’t this a frustrating situation ?
- You need a break from your regular work but, you have been postponing because of your commitments.
You could add more to it, however, the essence of this is SAVINGS. When an emergency strikes harder, you should be financially prepared to deal with it.
Ant’s work harder to prepare for the worst scenario. Proverb says, Plan for the worst; Hope for the best.
Sticking to this principle retrospect to understand why an emergency fund would be needed.
How ?
When we discuss about “Emergency Fund”, the first thing that strikes me is:
What is your Income ?
What is your Expenses ? (Note: Expenses are plural 🙂
So, let’s categorize people as below and try to find out how to SAVE for emergency fund.
No Income. No Expense & Has Income and NO Expenses
Rare to find such people. May be a sage ?
No Income. Has Expenses
Worst thing anyone can do is spending even before you earn. That is, you don’t have an income yet but, you are ready to spend. How is that possible ?
Credit Card :). For those who are falling under this category all I would say is avoid DEBT. Avoid this TRAP. Earn and Spend.
Has Income. Has Expenses
Target audience would be these friends who have constant income as well as constant expenses. The problem they face is they don’t understand the importance of emergency fund nor do they think about it or do it correctly.
Having said that, what is that I want to recommend now for such friends.
Here is a simple table that captures the expenses done for the month of January to March. In this table, if you were able to identify the “Necessary expenses” and “Un-Necessary/Discretionary expenses” then you are in the first step of understanding your emergency fund.
| Expenses | January (Rs) | February (Rs) | March (Rs) | … |
|---|---|---|---|---|
| Streaming Subscription | 650 /- | 650/- | 650/- | |
| Watching Movie in Theatre | 1500/- | 0 | 750/- | |
| Rice | 450/- | 0 | 0 | |
| Long travel | 2000/- | 0 | 0 | |
| Milk | 750/- | 800/- | 600/- | |
| ….. | ….. | …. | ….. |
I would like explain in 4 steps on how to save for emergency fund. Refer the below diagram
Step 1:
The most important step and I have seen people doing it for years, months, weeks & days also. As per your convenience, repeat this until you were able to identify your discretionary expenses.
Step 2:
Once you have identified discretionary expenses, figure out the Habit that is forcing you to spend on this. In case, if you are unable to change the Habit think of an alternative way to change that habit. Once you have stopped spending on the discretionary expenses, start accumulating that.
Step 3:
Of course, if you are accumulating it that means you are storing it some where. Ideally, this is where “Greed” arises and psychology plays a major role in not letting that accumulated amount to spend it somewhere. If you have passed this stage/step, then repeat step 1 to 3.
Step 4:
It’s a state of mind. Some people say, I need max 3 to 6 months of expenses to be available in my Emergency fund. For some other people, it is for 18 months. Nevertheless, focus on steps 1 to 3.
Achieving step 4 should be the first goal for any one seeking financial independance.
Checkout this video for a crispy explanation on Emergency fund.
Other reference materials: Investopedia
Let’s talk about different ways of storing the emergency funds in the next article.