An emergency fund is a financial resource set aside to handle unforeseen expenses or financial setbacks. Its significance lies in its ability to provide a safety net during unexpected situations. Understanding what an emergency fund is and why it matters is crucial for sound financial planning.

What is an Emergency Fund?

An emergency fund refers to a designated amount of money set aside to cover significant and unforeseen expenses, such as

• Medical emergencies,
• Home appliance repairs or replacements,
• Major auto fixes,
• Unemployment.

Why do I need an emergency fund?

Establishing an emergency fund is crucial as it acts as a financial safety net, allowing you to handle unexpected situations without relying on credit cards or personal loan with high-interest rates obligations. Its primary purpose is to provide a sense of security and prevent further debt accumulation.

How much should you maintain in your Emergency Fund?

When determining the appropriate amount to save in your emergency fund, there are several factors to consider.

The short answer: As a starting point, consider setting aside an amount that can cover an essential bill, such as rent or groceries say NPR 10,000. However, it is advisable to gradually increase your savings over time.

The long answer: The exact amount that is suitable for you depends on your individual financial circumstances. A general thumb rule is to have enough savings to cover three to six months’ worth of living expenses. However, if you have irregular income, work freelance or seasonal jobs, or hold a position that would be easily replaceable, you may need to save a larger sum. In the event of job loss, these funds can be used to cover necessary expenses while you search for new employment.

Where do I put my Emergency Fund?

• High yield saving account
• Short term FD’s (3 months) or T Bills (91 days)
• Certificate of deposit

Choosing an appropriate place to keep your emergency fund is crucial. It is recommended to have your funds in a savings account with a high interest rate and easy accessibility. Since emergencies can occur at any time, quick access to your funds is essential. It is important to avoid tying up your emergency fund in long-term investments. A high-yield savings account is an excellent option, as it provides insurance coverage of up to NPR 500,000 per depositor, per ownership category, per financial institution, ensuring the safety of your funds. Furthermore, the money in a savings account can earn interest, and you can easily access it through withdrawals or funds transfers.

Worst place to put my Emergency Fund?

Everyday saving account: One drawback of keeping your emergency fund in an everyday regular savings account is the temptation to dip into the funds for non-emergency expenses. The ease of access and convenience may lead to spending the money with the intention of replenishing it later, which often never happens. This can result in a depleted emergency fund and a lack of financial security when unexpected expenses arise. To ensure the effectiveness of your emergency fund, it's important to choose an account that minimizes the risk of spending the funds unnecessarily. Consider opening a separate account specifically operated for emergency savings that offer better safeguards against impulsive spending.

Stock market: Investing your emergency fund in the stock market exposes it to significant volatility and market fluctuations, risking potential loss of principal, making it unsuitable for funds that needs to be readily available for emergencies.

Long term FD’s: Placing your emergency fund in long-term fixed deposits (FDs) restricts access to the funds for the duration of the FD term. Emergency situations may require immediate access to cash, which may not be possible with locked-in FDs. Premature termination can result in penalties, reducing the overall value of your emergency fund.

At home:

Similar to regular saving account, keeping cash at home may lead to temptation and spending the funds on non-emergency expenses, potential for loss due to theft, fire, or natural disasters. Funds stored at home do not generate any interest or potential growth, diminishing their value over time due to inflation.

How to build up Emergency Fund?

To build your emergency fund effectively, you can follow these steps:

Calculate the total amount you want to save: You can utilize an emergency fund calculator, such as the one provided by Vriddhi, to determine your six-month expenses.

Set a monthly savings goal: Instead of focusing solely on a large savings goal, break it down into smaller, achievable monthly targets. Accomplishing these milestones will provide a sense of accomplishment and motivate you to continue saving consistently.

Automate savings transfers. If your employer offers direct deposit, inquire about the option to allocate a portion of your paycheck directly to your savings account. This allows you to fulfill your monthly savings goal without the funds passing through your checking account.

Regularly assess and adjust your contributions. Take advantage of mobile apps and technologies such as Vriddhi to record your monthly spending habits. After a few months, evaluate your spending habits and savings progress and make any necessary adjustments. Once you have accumulated enough savings to cover six months of expenses, you may consider allocating any extra funds to investments or other financial goals.

By following these steps, you can effectively build an emergency fund that provides a sense of financial security and empowers you to handle unexpected expenses with confidence.