Monthly Emergency Fund Contribution: How Much Is Recommended?
In today's unpredictable world, having an emergency fund is a crucial step towards financial security. This separate amount, also known as a contingency fund, is saved for unforeseen financial needs, providing a safety net when unexpected events occur.
The ideal size of an emergency fund depends on one's age and monthly expenses. A good rule of thumb is to have enough to cover six to nine months' expenses. For instance, if you earn ₹50,000 monthly and spend ₹35,000 on expenses, your emergency fund should be between ₹2,10,000 to ₹3,15,000.
When it comes to choosing the right investment options for an emergency fund, liquidity, safety, and modest returns are key. The best options are high-yield savings accounts, money market funds, cash management accounts, and short-term certificates of deposit (CDs).
High-yield savings accounts (HYSA) are liquid, often allowing withdrawals within 1–3 days, and government-insured (e.g., up to $250,000 per bank). They yield higher interest than regular savings accounts without risking your principal.
Money market funds (MMF) invest in a diversified pool of low-risk instruments like short-term bonds and CDs. They offer competitive yields and high liquidity, making them suitable for short-term emergency needs.
Cash management accounts (CMAs), offered by brokerages, provide competitive interest rates, quick access to funds, and sometimes check-writing or debit card features, enhancing flexibility for emergency expenses.
Short-term certificates of deposit (CDs) provide higher fixed yields, but they typically lock your funds for a set period. Some CDs offer no-penalty early withdrawal options which add flexibility.
These options prioritize capital preservation and accessibility over high returns. Growth-oriented investments like stocks or mutual funds are generally not recommended for emergency funds due to market volatility and possible losses.
In addition to these, minimal-risk instruments such as savings account, recurring deposit (RD), fixed deposit (FD), debt mutual funds like ultra short-duration fund or liquid funds can also be used to maintain an emergency corpus.
Remember, the goal of an emergency fund is to provide a financial cushion during tough times. It's essential to avoid withdrawals except in emergencies, especially if you're using a savings account for your emergency funds.
Emergency funds can help manage financial needs arising from job loss, salary cuts, medical emergencies not covered by insurance, unexpected travel expenses, and more. Building an emergency fund is the first and foremost step in creating financial goals, ensuring you're prepared for whatever life throws your way.
[1] Investopedia. (2021). Emergency Fund. [online] Available at: https://www.investopedia.com/terms/e/emergencyfund.asp
[2] NerdWallet. (2021). Best high-yield savings accounts of October 2021. [online] Available at: https://www.nerdwallet.com/best/banking/high-yield-savings-accounts
[3] Federal Deposit Insurance Corporation. (2021). FDIC Insurance Coverage. [online] Available at: https://www.fdic.gov/deposit/deposits/deposits/
[4] Investopedia. (2021). Money Market Fund. [online] Available at: https://www.investopedia.com/terms/m/money_market_fund.asp
[5] Investopedia. (2021). Cash Management Account. [online] Available at: https://www.investopedia.com/terms/c/cash_management_account.asp
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