Covid 19 pandemic wreaked havoc on the lives of millions across the world. Many lost their jobs, their loved ones, and many kids were left in a bleak future without any parent to care for them. Amidst all the mess the one thing that could not be stressed more is the need for a fallback plan to ensure financial stability.
When a person has a steady source of income (like a salaried person), taking care of investments and creating an emergency fund becomes easier. There is a definite amount that is available each month and set aside a portion for emergencies is easier. But how can a person build their emergency fund if there is no steady inflow of funds? Given below are a few pointers that self-employed persons can use to build their emergency fund and safeguard themselves and their families against any unforeseen circumstances.
Why does one need an emergency fund?
Most of us plan for our future and have many investments to secure our retirement but not many keep an emergency fund in place to tackle any unforeseen situations. The result of this is that in any adverse situation, we need to break our investment portfolio and liquidate it immediately (sometimes at throwaway prices) to meet our financial needs which is not an ideal situation.
This is exactly why we need an emergency fund. An important point to note here is that having health insurance or life insurance is not equivalent to having an emergency fund. Your health insurance will not pay your bills if you have lost your job!
There is no exact number that can define the correct amount of an emergency fund. It varies from individual to individual depending on their family size, their lifestyle, their financial obligations, etc. However, most experts believe that an emergency fund should be sufficient enough to meet the financial obligations of a family for at least 6 months to a year. Anything lower than that may not be sufficient given the rising inflation and the current scenario of the economy.
How to build an emergency fund faster if income is not regular?
Let us now discuss a few key points that a self-employed person can use to build a good emergency fund.
- Account for the unavoidable expenses
The purpose of an emergency fund is to take care of the unavoidable expenses in an unfortunate event. These unavoidable expenses include rent, school fees, loan EMIs, SIPs, etc. These expenses should definitely be included in the emergency fund.
- Identify the avoidable expenses
Apart from the unavoidable expenses, our monthly budget also includes many avoidable expenses like eating out at restaurants, movies, our OTT subscriptions, vacations, etc. These expenses need not be mandatorily accounted for in the emergency fund. A person may include a rough estimate of approximately 10% – 20% excess than the unavoidable expenses for leisure even in dire times or simply divert them for any unexpected unavoidable expenses.
- Estimate the average monthly income as accurately as possible
While making a budget or making provision for an emergency fund, it is essential to know the total monthly income (direct or passive income) of the individual and the family as a whole. This will help to correctly evaluate the net amount that can be set aside each month without disrupting routine obligations as well as savings and investment.
- Look out for savings options to park emergency fund
When we create a fund it does not mean that the money should be kept idle in a savings bank account. This will not provide any adequate returns or contribute to the fund in a significant manner. It is therefore essential to opt for such investments to park emergency funds that can generate good returns and at the same time are liquid enough so the funds are released immediately.
- Do not tap into emergency funds for splurging
One of the cardinal rules of making an emergency fund is that the funds should not be used unless there is a financial emergency. If the person keeps removing funds from the emergency fund account for mere splurging, there may not be anything significant left at the time of any actual emergency.
Having an emergency fund is important for every person whether they are self-employed or have a source of income. Self-employed persons need to focus more diligently on building an emergency fund as the income is not constant, especially in the case of a person having a business that is seasonal in nature. Earnings from months, when the inflow of funds is higher, can be used to balance out the months where there is low or no income.
There is no definite or exact amount that can be quoted to be ideal as an emergency fund. However, most experts believe that an emergency fund should be equivalent to meeting the expenses for a minimum of 6 months to a year. In the case of a self-employed person, the higher the value of the emergency fund, the better.
Some options to park emergency funds include index funds, ETFs, liquid mutual funds, bank FDs, etc.
Yes. If sufficient allocation is made in the emergency fund after considering the monthly SIPs, they can be continued as they also help in securing the financial future of the person and their family.
A self-employed person needs to account for all the sources of income while calculating the emergency fund allocation whether they are directly from their business or profession or passive income like rent, returns from investments, etc.