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The importance of building an emergency fund

There is a popular fable about the ant and the grasshopper. While the ant toiled hard during the summer, the grasshopper would sing and dance and mock the ant by asking: “Why do you work so hard?” But when winter came along, the tables changed. The grasshopper became miserable, it no longer sang and danced and mocked. How could it? It had no food, no shelter during the damp, cold nights. The ant, on the other hand, remained well-stocked. This story conveys that one should work hard when times are good because no-one knows what the future holds.

This is precisely the reason you should create an emergency fund. The kitty you build can be a life saviour in tough times. It can help you tide over family or financial emergencies, loss of job and other such personal hardships. This is why saving for the future should be the first step of financial planning. Building an emergency fund is not tough as you’ll realise when you give the article a read.

How to create an emergency fund?

Like the ant, you have to be zealous enough to set aside a part of your income every month, without fail. The amount you save will comprise your emergency fund. As we mentioned in the previous chapter, it is advisable to save first and then spend on your monthly expenses. This way, the creation of your emergency fund will not be risked by your bout of overspending. At least 10% of your gross monthly income should be saved in order to build an emergency fund.

Where do you park your money?

Stashing money in your house is not a good idea. You may be compelled to use that money for every inconvenience you face. Now the question arises: where do you keep your money for financial emergencies?

The options

• Life insurance

You can choose to buy a life insurance cover. A life insurance can safeguard your family in case you are not around. The value of your term insurance plan should ideally be eight to 10 times your gross annual income. This will ensure your family doesn’t face financial upheavals in your absence.

• Health insurance

A medical emergency can drain out your wallet. To worsen matters, healthcare costs are rising sharply in the country. A nationwide survey found that the costs are growing at over 10%, both in rural and urban medical facilities. Hence, a medical cover is of vital importance. You may have to pay a small premium every year. But, the larger picture suggests that’s a small price to pay. Also ensure you opt for a critical illness cover. This can protect your finances in case you are diagnosed with cancer, have a heart attack or are suffering a life-threatening illness. In short, do not look at the money you are spending on a medical cover. You should, instead, look to get the optimal coverage in your medical cover.

• Liquid mutual fund

Life often throws different curveballs at you. For example, you may lose your job. In such cases, you need money at hand. This is where a liquid mutual fund can help you. You will get two benefits. One, the fund can give you decent returns at minimal risk while you are invested. Two, you can withdraw your investment as and when required.

• Bank balance

Your savings account can be of help too. Try and keep aside at least two months’ worth of your income in your bank account. The biggest advantage of having cash in your bank account is that you can withdraw any time, thanks to ATMs and debit cards.

To sum up

Planning an emergency fund is essential if you want to sail through life without any financial difficulties. So, create a contingency fund and invest it in suitable avenues.