Guide to building an emergency fund: Why it is needed, where should you invest?

No one likes to think of the things that can go wrong in the future but what happens to your finances when you encounter an unforeseen expenditure? Maybe it's a health scare, maybe it’s a loss of income, or perhaps it is for a major life event. These events can dip deeply into your savings and can shake your future financial plans. 

That’s why in the constantly changing landscape of financial planning, one pillar towers above the rest: the creation of a sturdy emergency fund. This fiscal buffer acts as a shield against the unexpected storms that can disrupt even the most well-structured financial plans, providing individuals with a crucial lifeline during times of crisis. An emergency fund is the unsung hero of financial preparedness, offering reassurance and peace of mind in times of turmoil. 

By diligently constructing a fund capable of covering several months' essential living expenses, individuals build a safety net that cushions against unexpected challenges. Opting for secure and easily accessible investment avenues safeguard the fund's utility, ensuring a shield against whatever life throws your way. In a world where financial readiness is a virtue, an emergency fund stands strong as a bastion of fiscal resilience. 

But creating an emergency fund can seem more complicated than it is. 

Strategically Growing Your Emergency Fund

There are two important factors when you want to save up to create an emergency fund. The first million-dollar question is: how much should one set aside for an emergency fund? The second important question is more complicated: what assets to invest in? 

Let’s answer the first question. Generally, financial professionals suggest that individuals should at least save up to three to six months' worth of essential living expenses. You should calculate all fundamental necessities like rent, utility bills, groceries, and essential loan payments. Try to err on the side of overestimation, as it would be better to save more than you need rather than save less than what you may require. 

Now to the second question. The ideal financial instruments and assets to invest in are those that have a few critical characteristics. These include being relatively liquid and flexible while still offering safe returns. Ideally, you would also want to invest in assets and instruments with returns that at least match if not exceed the current inflation rate. 

Here are prudent options to consider:

Savings Account: A classic choice offering immediate access to funds when needed the most. Savings Accounts offer highly liquid solutions and are highly safe as well. The Reserve Bank of India’s Deposit Insurance and Credit Guarantee Corporation (DICGC) secures and insures all savings deposits up to Rs 5 lakh in value. However, the safety and liquidity came at the expense of lower returns. 

Fixed Deposits: A dependable avenue that marries stability with adaptability, empowering you to select the deposit term that aligns with your specific circumstances. Fixed deposits offer a secure and predictable option for growing your funds while maintaining the flexibility to tailor your investment horizon.

Liquid Funds: Within the realm of mutual funds, liquid funds emerge as a beacon of low-risk alternatives, characterised by swift redemption and elevated liquidity – a perfect fit for exigencies. These funds stand ready to serve during emergencies, striking an ideal balance between safety and accessibility.