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This is the 4th and final of our ‘Emergency Fund’ article series.
We recommend you go through the previous 3 parts first:
Part 1: What is an Emergency Fund? →
Part 2: How Much Should You Have in Your Emergency Fund? →
Part 3: Where to Park Your Emergency Fund? →
By now you have probably realised the importance of an emergency fund. The next question on your mind is - How Do I Create My Emergency Fund?
The best thing about creating your emergency fund is that it is not at all a complex process like, say, creating a long-term investment portfolio or choosing the right insurance policy.
To start creating your emergency fund, you need to first decide on the instrument and amount.
Read this article to decide your emergency fund size: How Much Should You Have in Your Emergency Fund? →
In this article, we presented some 3 good instrument options for your emergency fund. You should select one of them. We recommend fixed deposits. Here’s why:
Why Fixed Deposits Are The Best Instrument To Park Your Emergency Fund
Your emergency fund needs to have 3 essential qualities that are, incidentally, the features of fixed deposits:
Very low risk
You don’t want your emergency fund to be in high risk assets like stocks, equity mutual funds or fancy alternative assets.
While these high risk assets are more likely to perform than fixed deposits over the long term, their performance in the short term can be very volatile. So, you may have to withdraw your emergency fund at a loss - something you absolutely should avoid.
Fixed deposits generate fixed returns at very low risks making them the perfect instrument for your emergency fund.
FDs are insured up to Rs. 5 lakh per bank per depositor. This unique feature further reduces their risk.
Easy to access
Your emergency fund needs to be easily accessible for obvious reasons. Further, the easy-to-access feature should be very easy to not come with any strings attached.
Real estate is definitely not easy to access. Stocks, while easy to access, are high risk. Same goes for equity mutual funds.
Fixed deposits are very easy to access and offer great liquidity.
You can call your bank to withdraw money from your fixed deposits and it gets deposited into your savings account on the same day!
Decent returns
Fixed deposit interest rates are at their highest levels in the last 10 years.
So, it is high time that we stop looking down upon fixed deposits as we did thanks to social media in the last few years.
Not only are fixed deposits great for parking your emergency fund in 2024 but generally saving your money to earn 8%+ returns fixed returns.
How To Create Your Emergency Fund?
Irrespective of your instrument of choice, there are two ways to create your emergency fund:
1. Through a single lumpsum investment all at once
2. Through a series of small investments
If you have your emergency fund corpus simply lying in your savings bank account, it is only a matter of transferring it to your instrument of choice.
This is possible for all suitable instruments right from fixed deposits to liquid funds.
But it may not be feasible for everyone. In this case, you can simply transfer an appropriate amount to the instrument of choice.
For the balance amount, simply start a series of small investments.
➡️ Auto-sweep facility for fixed deposits
➡️ SIPs (Systematic Investment Plans) for liquid funds
➡️ Manual transfers for all other instruments
The next question you may have:
How should much I transfer to my emergency fund every month?
It varies from person to person. The idea is to build your emergency fund as quickly as possible without stopping critical expenses/outflows.
So, it makes sense to divert your regular long-term investments like SIPs to your emergency fund until you have accumulated enough.
But it wouldn’t make sense to stop your gym membership or insurance premiums and divert it to your emergency fund.
You know your emergency fund target, all you have to do is save money in your instrument of choice until you meet that target.
Happy investing!
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