Most of the financial advisers suggest to build a emergency fund which can be used on a rainy day. The main advantage of setting an amount aside is at the time of need, one need not break the long term investments made.
It will help you maintain you future financial commitments by taking care of the present financial situation.
Determining how much emergency fund is needed is very important, so that the amount set aside is not higher or lower and matches your needs at that moment.
Life is uncertain and one should be financially prepared to face it. Here are few smart ways to build an emergency fund:
1) Keep it separate
The first step is to keep the account separate and not mix with any other investments. One can keep the amount in high interest paying savings account, where you will gain by way of interest.
Once you feel the amount is sufficient, you can put an extra amount and use it for any other investments such as Fixed Deposits, Mutual Funds or Bonds.
Investments should be made considering the risk factor and tax bracket fall into.
Individuals in higher tax bracket, should plan tax in such a way that there is no much deduction and one when they file for returns, they should be able to get a tax refund.
Such a tax refund can be used as an emergency fund.
3) Credit Card
Living on credit card are expensive way of living as it will lead to spend more and save less. Reduce your spending starting from a small amount.
Be realistic when setting the amount aside. One can also reduce higher interest bearing credit cards. Savings on these can help you build an emergency fund.
4) Salary Income
If there is a hike in salary or one can set aside small monthly amounts regularly, setting aside around Rs 2000-Rs 3000 per month won't have much of an impact.
Initially, one can start with small amount and increase it over a period of time.
5) Short Term investments
One can also park money in short term investments ranging from few days to a few months. However, one should consider the withdrawal or penalty charges and the liquidity of the instrument.
The basic question here is when we can use this emergency fund for. One can use for unexpected medical expenses which are not covered under your insurance. Job loss, to make loan payment etc.
Note that this fund should not be used for vacations, branded clothes, or other luxuries. Else the motive of having emergency fund fails.