How to build an emergency fund
An emergency fund is money set aside for the things you cannot schedule: a job loss, a medical bill, an urgent repair. Its job is to be there, not to earn.
How much
Add up one month of unavoidable spending: rent or EMI, groceries, utilities, school fees, insurance premiums, transport. Then multiply:
- Three months if you have a stable salary, a second earner at home and no dependants.
- Six months for most households.
- Nine to twelve months if your income is irregular, you are self-employed or you are the only earner.
At ₹40,000 of essential spending a month, a six-month fund is ₹2.4 lakh.
Where to keep it
Three tests decide: the value must not fall, you must be able to reach it within a day, and it should earn something.
- Savings account for the first month’s worth. Instant, low interest.
- Sweep-in or flexi fixed deposit for the bulk. It earns FD rates and breaks automatically in units when you withdraw.
- Liquid mutual fund as an alternative for the bulk. Redemptions usually reach your bank the next working day.
Shares, equity funds, property, gold jewellery and locked-in products such as PPF fail at least one test.
Building it on any income
- Open a separate account so the money is out of sight of daily spending.
- Automate a transfer on salary day, even ₹2,000. A recurring deposit is a simple way to force the habit.
- Send windfalls there first: bonus, tax refund, gifts.
- Pause other investing until you reach at least three months. Returns elsewhere do not help if a crisis forces you to borrow at 18% or more.
Insurance is the other half
An emergency fund handles small and medium shocks. Health insurance and, if anyone depends on your income, term life insurance handle the large ones. Without cover, one hospital stay can empty the fund several times over.
When to use it, and what next
Use it for needs that are urgent, necessary and unexpected. A sale on phones is none of these. After any withdrawal, rebuilding it becomes the first financial priority again.