What is an emergency fund? And why you should have one?

In personal finance and money management, emergency fund is the first line of defense against the unexpected problems in life. Financial emergencies can happen anytime, and most of the time they occur without warning.

  • What if your car needs immediate repair?
  • What if you are out of job for a couple of months?
  • What if you broke your leg while playing gully cricket?
  • What if a sudden voltage surge damaged your TV/Fridge/AC and all devices?
  • How you are going to tackle this?

Times are good, you can draw money on your credit card, or you can swipe your card to get new TV/New AC etc. You can take personal loans to pay for the home expenses if you are not in job for a couple of months. But all these options come at a cost. Cost is 18%-24% rate of interest per year.

So, you must have an emergency fund, which is money stashed away in an account which is reachable at a short notice of about 1 working day. Now the question is How Much? There is no thumb rule to it. 3 months of living expenses should be sufficient so that in worst case you do not have to rush out and get money on credit.

You can use a high interest sweep in account of any bank or a liquid / cash mutual fund. Mutual fund option is better as it saves you from the high tax if you are in higher tax bracket. Any liquid mutual funds can be cashed in 1 working day. You do not have to plan to earn huge interest on your emergency fund, but let it sit in some avenue which gives some returns and which is easily accessible.

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