The famous American investor and motivational speaker T. Harv Eker once said, “Financial freedom is the ability to live your life on your own terms”. Financial freedom is akin to financial independence that you must strive for at each step of your life. As we talk about India’s long journey since it first tasted independence from colonial clutches, let us also focus on the fact on the importance of one’s financial independence.
Planning the first step to financial freedom
As described by Suze Orman, a noted American businesswoman and successful investor, “Financial freedom is not about having a lot of money. It’s about having enough money to do what you want to do, when you want to do it, without having to worry about money.” However, this is possible only when you have set aside enough money in a contingency fund to pay for unexpected events.
Establishing an emergency fund is a prudent approach to prepare for unforeseen financial needs. By doing so, you avoid dependence on high-interest debts like credit cards to manage unexpected expenditures.
The size of your emergency fund will be contingent upon your individual circumstances. A general guideline is to amass sufficient funds to cover living expenses for three to six months. This ensures that in the event of job loss, you can afford your mortgage or rent, utilities, groceries, and other essential outlays for a minimum of three to six months.
If immediately saving three to six months’ worth of living expenses is unattainable, start by accumulating whatever amount you can. Even a modest emergency fund can offer vital assistance in a crunch.
How to build an emergency fund?
Once a basic emergency fund is established, you can escalate your savings efforts to ultimately achieve the three to six months target.
Here are some strategies for building an emergency fund:
Define a target: Begin by assessing your monthly expenses comprehensively. This encompasses essential outlays like housing, food, transportation, utilities, and debt obligations. Utilizing a budgeting tool or app, track your expenditures for one to two months to gain a precise understanding of your monthly spending patterns.
Next, multiply your monthly expenses by a factor of three to six. This calculation will yield a preliminary approximation of the requisite emergency fund amount.
Factor in your unique circumstances. Tailor the determination of your emergency fund size to your personal situation. For instance, if you have dependents, a larger emergency fund is advisable compared to a single individual. Additionally, assess your job security and risk tolerance. If your employment is susceptible to layoffs, a more substantial emergency fund becomes crucial.
Devise a strategy to accomplish your target. With a clear emergency fund goal in mind, chart a course to achieve it. Construct a plan that outlines both a timeline for attainment and a method for regular savings.
Exercise prudence in pacing your savings efforts. Avoid amassing funds too rapidly, as this could impede adherence to your plan. Strive to allocate a fixed sum each month, ensuring steady and achievable progress toward your goal within a rational timeframe.
Automate savings: Arrange a recurring monthly transfer from your checking account to your savings account. Once established, this transfer will execute automatically according to your chosen schedule, streamlining your emergency fund savings effortlessly.
Ensure your checking account maintains sufficient funds to accommodate the transfer. Prevent overdrafts by staying mindful of the scheduled transfer. Regularly monitor your account balance to verify the successful execution of transfers. Vigilantly overseeing your finances, particularly during the initiation of new automated transactions, is a wise practice.
If necessary, make adjustments. If your current savings rate falls short, consider elevating the monthly transfer amount or altering the transfer frequency to a more frequent interval.
Trim expenditures: Numerous avenues exist for reducing your expenditures, and incremental modifications can yield substantial results over the long haul. Through minor adjustments to your spending patterns, you have the potential to accrue significant monthly savings. These funds can subsequently be allocated to your emergency fund or directed towards accomplishing other financial objectives.
Pursue extra income: Engaging in a side hustle presents a valuable opportunity to generate additional income, which can be allocated towards bolstering your emergency fund or achieving other financial aspirations. An array of diverse side hustle options exists, allowing you to identify a pursuit that aligns with your talents and passions.
Cultivating an emergency fund constitutes a significant stride toward bolstering your financial stability.
Growing your emergency fund
Just planning an emergency fund and allocating enough money to it regularly will not help. You must aim to augment the amount in it by investing the fund money in high-yield savings accounts, fixed deposits, debt funds, and money market securities. Some banks also offer high-interest rates on recurring deposits and flexi deposit schemes, thus, allowing you to make either fixed or flexible deposits to these accounts. Recurring deposits work best for salaried people while self-employed professionals, especially, freelancers can rely on flexi deposits to earn interest on the money they deposit in these accounts.
Investors have the option to allocate approximately 30-50 per cent of their investible funds into liquid funds, as these funds provide enhanced liquidity and superior returns compared to a traditional savings account. By directing a significant portion of the emergency fund towards these investment schemes, liquidity remains secure, allowing investors to redeem their funds within a short span of a few days.