One has to always brace for trying and tough times, whether it is a sudden health hazard or simply loss of a job.
In such times an emergency fund comes in handy. Many individuals advocate an emergency fund to meet 6 months of household expenses, including loans, school fees etc. However, it is better to make provisions for at least a year's requirement, working on the worst case scenario.
How to create the emergency fund?
1) Create a fund that is liquid
An emergency fund should be liquid. What this means is that you should not place them in illiquid instruments like PPF or ULIPs which have a lock-in. The ideal place to put these would be bank deposits as they are very liquid.
Though shares are liquid you might want to avoid placing them in shares because in case you are incurring losses, you might be forced to sell the shares at a loss.
However, you might want to look at debt funds that can be withdrawn and are very liquid.
2) The amount can vary
You can vary the amount that you place towards the contingency fund. So, if you have decided to build a corpus after one year and you run a shortfall in a particular month, you can compensate for the same in another month.
3) Make sure the amount earns you money
Do not keep the money idle in the bank, but, place the money in some deposits. It is good that the amount earns you some interest as you may never know when the emergency could come.
4) Don't withdraw the emergency fund
You should not draw from the emergency fund for a need like a sudden holiday. This should be the last of the funds that you should be touching.
5) Maintain monthly discipline
Make sure that you do not skip placing an amount each month in the emergency fund. Once you have achieved your target, you can save money for other needs like a holiday or for your retirement as the case maybe.
It is very important to begin creating an emergency fund, that would serve you in times of crisis. Maintain a discipline by which you can build a corpus over a period of time, though shorter the better.