An emergency fund is an essential buffer to tide over in unforeseen circumstances. You need a safety net when life throws those harsh bouncers at you. Most financial advisors advocate an emergency fund equivalent to 6 months living expenses. Living expenses here include only the necessary costs such as grocery, utility bills, EMIs, insurance premiums, children’s school/tuition fees, etc. While 6 months is taken as a rule of thumb, it cannot be a blanket solution as personal situation varies from individual to individual. Here are a few scenarios which if relevant to your financial life would require you to beef up your emergency fund beyond 6 months expenses. The reserve could be at least for 1 year’s living expenses or even higher:
Working in a high attrition industry
If you work in an industry where layoffs are common, then you need to review your emergency fund. In the present digital age, the dynamics of doing business are changing fast and the advancement of technology has made and will continue to make many jobs redundant. This holds true the most in service related industries like IT. No matter the designation and the experience, the axe can come falling any time. If you are working in such an industry, then you need to stack up your emergency fund equivalent to at least a year or even more of living expenses. It could be a while before you get a new offer and a bigger emergency fund will help you sail through the jobless times without stress.
High Debt
If 40 per cent or more of your income goes in servicing EMIs and credit card loans, then you need to scale up your emergency fund. In the event of a job loss, a bigger contingency fund will help to fulfil your huge debt obligations without any financial pressure.
Big family dependant on single income
If you are the sole breadwinner and have many family members depending on you, the importance of a bigger emergency fund cannot be undermined. In the event of your hospitalisation where you are incapacitated to work for a while or even in the event of you losing job, a six month emergency fund would not suffice. You would need more than that to avert any financial hassles and take care of all your dependants.
Self–employed
Businesses go through cycles depending upon the economic and industry situations. Incomes from business are hence unpredictable and inconsistent. If you are self-employed, you need a bigger emergency fund to meet your living expenses during recessionary times. If you are contemplating to start your own venture, you would need to first set up a big reserve to meet any personal contingencies.
Switch career
The decision to switch careers implies a major financial change. If you are planning to work in a new field, it would entail starting you career from scratch and making a major compromise on current income. Here again, a six month emergency fund will not be adequate and you would need to beef it up.
Erratic Income
Income from freelance work is usually irregular and on a project or period basis. So, if your primary income is dependant upon freelance work as a writer/ IT or business consultant, then you need to re-examine your emergency fund. Having a bigger emergency fund will act as a cushion in the event of a lull period in terms of work or any other bumps you experience in your financial life.
As suggested earlier, the amount in an emergency fund would depend upon your personal and financial situation. A solid emergency fund would help you avoid derailing your financial journey.