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Emergency Fund: How Much to Save and How to Calculate It?
An emergency fund works as a financial shield for your finances and protects you from uncertain financial emergencies in life. It is money set aside to pay expenses without affecting the budget or long-term savings. It provides a peace of mind and a sense of stability during times of need, whether during medical problems, unemployment, unexpected travel, or other emergencies.
This article will provide a complete guide on how to build and calculate emergency funds. Also learn where to keep your funds safely and its importance.
What is an Emergency Fund?
An Emergency Fund is a fund created to provide additional security against unforeseen financial expenses. They are used in situations such as medical emergencies, unemployment, automotive repairs, or home repairs, providing an option to avoid borrowing money or using a credit card. Financial experts recommend saving three to six months of basic expenses in a separate “Emergency Fund”.
This amount should be deposited in a separate account that is easily accessible at any given time. The goal of an Emergency Fund is to give you peace of mind and financial security, while at the same time allowing you to maintain your long-term financial security and achieve long-term financial goals even when experiencing unexpected events.
Why Every Indian Must Have an Emergency Fund?
An emergency fund helps face any uncertain events due to the availability of funds. The following are the reasons why an emergency fund is important:
Job Loss: Facing unemployment due to layoffs or business closures is a major financial crisis, but an emergency fund might help overcome the situation.
As per data from “India’s Money Habits” it was found that 1 out of 4 Indians cannot last even a month if they lose their job.
Medical Emergency: If a medical emergency occurs and requires you to incur hospital bills, even after you’ve paid your insurance costs, a medical emergency fund is a good way to be prepared to cover the expense of paying bills.
Family Expenses: In many Indian households, unexpected expenses related to the family can occur at any time, such as providing financial assistance to parents or other relatives and funding educational expenses.
As per reports, it is known that Indians consider their parents or friends as an emergency fund. One out of three has neither an emergency fund nor health insurance.
Unexpected Travel: Expenses incurring due to work or sudden relocation can all be covered using an emergency fund.
Home Repairs: These funds are very useful to meet home repairs such as electrical and plumbing issues, broken appliances, etc.
At least 75% of Indians do not have an emergency fund revealed by a survey by a personal finance platform.
How Much Emergency Fund Should I Have in India?
What is the ideal emergency fund amount? The size of the fund will be based on the level of job stability, income predictability, and the number of responsibilities that you have as an individual. There is no ‘one-size-fits-all’ approach to how much you should set aside in savings.
Instead of guessing, calculate your exact emergency fund requirement using our Emergency Fund Calculator
3-Month Emergency Fund (Stable Jobs)
A person working as a government employee or holding down a long-term corporate position and receiving regular salary earnings would benefit from a 3-month rule, which is thought to be sufficient to address unforeseen medical issues and financial crises.
6-Month Emergency Fund (Mild Risk Jobs)
A 6-month emergency fund can be created if your job is uncertain (example: performance-based roles, or roles with potential for layoff). The 6-month rule will provide you time to find a new job and to pay your monthly rent or fulfill family obligations if your income declines.
12-Month Emergency Fund (High Risk / Self-Employed)
Individuals who are self-employed, freelancers, or business owners have irregular or inconsistent incomes. A 12-month emergency fund will help them support their financial decisions without borrowing money.
Emergency Fund Calculation Examples
To know how to calculate emergency funds in India, take your income and real expenses into consideration. Examples below show the savings calculation for 3 months, 6 months, and 12 months of emergencies.
Example for ₹20,000 Income
If you earn ₹20,000 a month and spend around ₹15,000 a month, then you need to have at least 3-6 months of emergency funds.
Example for ₹50,000 Income
If you are earning ₹50,000 monthly and spending ₹30,000, then establish a 6-month emergency fund.
Example for ₹1,00,000 Income
For individuals earning ₹100,000 or more monthly and spending ₹60,000 or more, create a 6-12 month fund. It is needed to cover expenses such as rent, home loan (EMI) payments, etc.
Emergency Fund Amounts for Different Income Levels in India
Income | Monthly Expenses | 3-Month Fund | 6-Month Fund | 12-Month Fund |
|---|---|---|---|---|
₹20,000 | ₹15,000 | ₹45,000 | ₹90,000 | ₹1,80,000 |
₹50,000 | ₹30,000 | ₹90,000 | ₹1,80,000 | ₹3,60,000 |
₹1,00,000 | ₹60,000 | ₹1,80,000 | ₹3,60,000 | ₹7,20,000 |
Where to Keep Your Emergency Fund Safely in India?
Emergency Funds consist of liquid, protected, and stable funds that are held for emergencies and should not be invested in volatile investments. Several options below have been identified as the best options to store your emergency fund in India, along with their pros and cons.
1. High Interest Savings Account
Pros:
– Highly liquid and can be accessed at any time
– Higher Interest than a traditional savings account
– Safe with little to no risk
Cons:
– Will have a change in interest rate over time
– Returns are lower in comparison to long-term investments.
2. Sweep-in FDs
Pros:
– Higher interest with easy access and automatically transfers into savings.
– Safe and reliable
Cons:
– Some banks may delay your process of taking out funds, or if you take out early, you will lose interest.
3. Cash-in-Hand for Emergencies
Pros:
– Can access money immediately in urgent medical situations or emergencies
– It can be used if other payment options are not working.
Cons:
– No interest earned
– Risk of theft or overspending
Step-by-Step: How to Build Your Emergency Fund?
Do you know how to build an emergency fund? The process of building an emergency fund should not be complicated. Learn below how to build an emergency fund step by step:
Step 1: Calculate Monthly Expenses
List the major expenses that need to be paid each month (e.g., Rent/Mortgage (EMI), Food, Utilities, Insurance, Transportation). By calculating the major costs, you will know what your baseline is for an emergency fund.
Step 2: Choose your Emergency Fund Goal
3-6 months of your monthly expenses is ideal for most people, but if you have a volatile income, then consider targeting 9-12 months of expenses.
Step 3: Start with a small amount (₹500–₹2,000)
If money is tight, begin by saving ₹500 – ₹2,000 every month. It’s not about how much you save, but forming the habit of saving.
Step 4: Right Place of Saving
Always use safe and liquid savings products like a High-Interest Savings Account or FD so that you can access your funds anytime.
Step 5: Automate your monthly savings
Set up Automatic Transfer of funds after you get paid so that you do not spend your savings.
Step 6: Cut Expenses
Decreasing food delivery, subscription, impulse purchases (and other small expenses) will free up funds to put towards your emergency fund.
You can also use frameworks like the 50/30/20 budget rule to systematically free up money for your emergency fund.
Step 7: Increase contribution annually
When you receive a raise and/or bonuses, be sure to contribute additional funds toward your emergency fund.
Step 8: Track and Adjust
When you receive a hike or bonus, be sure to track and save your money toward your emergency fund.
Emergency Fund vs Savings Account: What’s the Difference?
Find below the difference between emergency fund and savings in the form of a table:
Category | Emergency Fund | Regular Savings |
|---|---|---|
Purpose | Created for unexpected situations | For planned expenses such as travel, gadgets or future purchases |
Usage | Can be used during emergencies such as medical issues or job loss | Can be used without any restrictions |
Accessibility | Instant access as they are kept in highly liquid accounts | Can be stored in RD, FD or savings accounts |
Amount Needed | 3–6 months of expenses | Flexible based on the goals |
Risk Level | Low-risk and stable options | Includes moderate risk depending on goals |
Emergency Fund vs Savings Account: What’s the Difference?
Below are some common mistakes people make with emergency funds. Take a look.
1. Saving Less
Many people don’t save as much as they should. That’s why the emergency fund should be large enough to cover three to twelve months’ expenses.
2. Investing Emergency Money in the Stock Market
The stock market is volatile and will decrease the value of your savings, especially at the times they are most likely needed. The emergency fund should consist only of safe and liquid investments.
3. Keeping too much Cash
Keeping too much cash at home is unsafe and will decrease in value due to inflation.
4. Using Credit Cards
While using debt may help in an emergency situation, using credit cards as an emergency fund increases financial burden and taxes on your ability to repay loans or pay back the debt.
5. Failing to Adjust Funds for Inflation
As living costs rise over time, so too should the emergency fund amount.
6.Combining Emergency Savings with Regular Spendings
When you put all your savings in one account, people tend to use the emergency fund for non-essentials.
7. Irregular Savings
Saving only when you can is less effective than saving on a monthly basis.
Final Thoughts
Emergency funds are one of the best ways of achieving financial security. Unfortunately, many do not consider the importance of having an emergency fund until they experience an unexpected event. The benefits of an emergency fund are for providing both emotional and financial support. Having a financial cushion such as cash savings will help experience a lower level of anxiety and fear during unexpected financial circumstances. It will reduce the need to rely on credit cards, high-interest loans, and borrowings.
An emergency fund ensures that your financial future is not affected. It provides peace of mind and protection. Start with a small amount, practice discipline and allow your emergency fund to create a strong financial foundation.
Frequently Asked Questions (FAQs)
To calculate your emergency fund, sum the monthly expenses and multiply by 3, 6 or 12. With this you will know how much amount to save for the emergency fund after calculating the expenses.
The 70-10-10-10 rule offers a stress free way to manage money. Divide your income into four parts: 70% for daily expenses, 10% for savings, 10% for investments, and 10% for debt repayment.
The 3-6-9 rule for emergency funds refers to savings of 3, 6, or 9 months of take-home income. 3 months for stable earners, 6 months for couples with kids, mortgages, and 9 months for those with unpredictable income.
The 3-6-9 rule of money means to set aside money to cover expenses for three, six, or nine months, depending on needs and financial situation. It's a guideline to build financial security through focused and small actions.
How big or small the emergency fund should be depends on one’s financial needs. A good amount from the net income can be saved for 12 months into emergency funds and can be used when the need arises.
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