Building an emergency fund: Key factors to consider for effective savings strategies

An emergency fund is a cash reserve created or set aside to meet unforeseeable expenses. Emergencies could be of varied types such as car repair, illnesses, an accident or loss of income or a job. These can arise anytime due to an uncertain future.

So, building a contingency fund should be on the top of the priority list of any individual, be it a savvy market investor, a businessman or a salaried person to meet sudden expenses.

It could be a daunting task building an emergency fund without effective savings strategies. Many of us often face a dilemma about the size of the emergency fund or how much to invest regularly for building an emergency fund. However, experts agree on having sufficient funds to meet at least three to six months of expenses.

The size of the emergency fund may depend on your lifestyle. It could be easier for building an emergency fund if you build an investment strategy taking a few factors into consideration.

Saving money is key to dealing with such uncertainties in life and at the same time having a quality living standard. Individuals can have different goals such as retirement, higher education of children, financial independence, debt resolution or financial security. But, meeting these goals requires one path - creating a mindset for saving money.

Savings rule or how much you should save

The most widely suggested savings rule is 50/30/20. An individual should save at least 20% of the income for his or her future needs. As much as 50% of income should go for necessities or needs and 30% of the income on discretionary expenditure or wants. While there are contrary views on a rigid savings rule, an individual can adopt a flexible savings strategy as per his financial journey and long-term goals. A basic and simple savings rule is - you spend less than you earn.

Saving strategies for building emergency fund

When it comes to savings, the first thing people think of is cutting back on expenses like eating out, travel and discretionary spends. But there are other savings strategies that allow an individual to spend less and earn more.

Set Savings Goals

Setting a savings goal is key to creating a pool of money for the future. Emergency fund corpus should be at least three to six months of total expenses such as regular EMIs, school fee and others. There could be a long term emergency fund to meet expenses for medical emergencies and others.

Create Budget

Creating a monthly budget helps allocate the required money for regular expenses. Budgets are useful in tracking expenses and knowing where the money is going. Various budget techniques can be used to allocate money. A budget will help carve out funds for building your emergency fund.

Cut costs

Cutting down unnecessary spending can help bring down living costs and save extra money, especially in the short term. Mindful use of credit cards can help save money as buying things by credit cards is very simple but there are hidden costs that make the usage a bad financial decision in the long run. Paying off outstanding credit bills can save various charges levied by credit card companies. Cancelling unnecessary subscriptions of entertainment apps, music or magazines is also a smart move to leave extra money in your pocket.

Automate Savings

After getting a clear understanding of monthly expenses through budget, you can go for the automatic transfer of savings into separate accounts.

Payoff Debt

Individuals can save more by paying off debts. Targeting a debt with high interest rates can help free up additional funds for savings. Credit card outstanding balances are a big drag on savings and these should be targeted first.

Where to invest for building an emergency fund

The basic thumb rule for the investment of emergency funds is easy accessibility. As it is a fund for contingencies it should be readily available when required. Individuals can keep the emergency fund in cash form, in high-yield savings plans and also liquid mutual funds. It is not advisable to keep short-term emergency funds in riskier assets such as stocks and funds which take some time for liquidation.

Fixed deposits, overnight funds and liquid funds could also be suitable options for keeping emergency funds.

Individuals can consider liquid funds which are usually debt mutual funds of low duration and offer higher returns.

Invest in financial products for long-term emergency funds

While cutting down on costs is a short-term strategy for saving money, individuals should also explore putting money into long-term investment options. These help in creating a large pool of funds for the future.

Some investment options give better returns than bank deposits and can help people achieve their financial goals faster.

ULIPS

Unit-linked investment plans offer options such as equity, balanced funds and debt and earn higher returns in the long term. Mutual funds are also an attractive option for creating a long-term pool.

Stocks

Stocks are also a better option for long-term investments. However, individuals should be careful about picking stocks and keep a close watch on the market trends for secure investments.

Index Funds

Index funds are also ideal tools for creating long term savings as they are less risky than individual stocks.

A clear blueprint of savings strategy is the key to achieving the goal - be it creation of an emergency fund, vacation planning, buying a new house or a long-term saving plan. A mix of these strategies can help meet your financial goal easily.