Why is it important to have emergency fund?

When it comes to financial planning many financial advisors and financial planners asks you to have emergency fund or contingency fund in place. So what is emergency fund and why is it so important for you to have at first place way before providing anything for your financial goals?

Emergency fund or contingency fund, as the name suggests is the corpus that would help you in the time of your rainy days. In case, there is any emergency for which you require urgent cash then emergency fund may come to your rescue without compromising on your investments that you have made towards your financial goals or commitments on your EMI’s (Equated Monthly Instalments). So it is very important to have it in first place.

Now the question would be how much one must have as an emergency fund? There is no hard and fast rule but anything around your three to six months of expenses would be a reasonable amount for your emergency fund. Still it depends on the occupation you are in. If you are in such a occupation where you need to search for jobs frequently or if you are self-employed then you may require emergency fund up to your six to eight months of expenses. On the contrary, if your job is pretty much stable then 3 months of expenses in an emergency fund would do.

Let’s take an example to understand it better. Mr. Ramesh is working as a finance officer with ABC Ltd. and has a monthly expenses of Rs. 30,000 and EMI of Rs. 20,000. So the total monthly outgo comes to Rs. 50,000. So assuming his job is stable, he would require Rs. 1.5 lakhs as an emergency fund. It would be prudent for Mr. Ramesh to manage these Rs. 1.5 lakhs by maintaining Rs. 50,000 i.e. his monthly outgo in his savings bank account Rs. 10,000 to Rs. 15,000 as cash at home and remaining Rs. 85,000 to 90,000 to be parked in liquid mutual funds.