Imagine if one day your job was suddenly lost or a loved one faced a medical emergency. In such situations, people often get caught in credit cards or high-interest personal loans. Did you know that according to a survey, 75% of Indians have no emergency savings for such difficult times? The truth is that in India, most people don't think about emergency funds and make common mistakes when dealing with emergencies. So, in this post, we'll understand a four-step framework on how to build an emergency fund.
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| 4 Steps To Build Emergency Fund Without Mistakes |
Reasons For Not Building An Emergency Fund
First, let's talk about the reasons why we Indians are unable to build an emergency fund. The first reason is that our per capita income is low. Because of this, our expenses on food and essentials are higher. The monthly per capita expenditure on essentials and food in rural India averages around 47%. In urban India, it's around 40%. Besides this, our net financial savings per household are only ₹53,000 per year. But if we look at expenses, if emergency medical treatment arises, the cost per day for an ICU alone can be ₹20,000 to ₹30,000. Secondly, insurance penetration in our country is also so low that only 41% of households have one or more people covered by insurance. So this is a constraint where we don't have enough money left to even think about an emergency fund. For this, first, we should definitely get health insurance because, as of today, anyone can cover themselves. The premium isn't that high.
Second, we should definitely insure our lives too. Get a term insurance. After that, only then do we move on to the emergency fund. Now, let's talk about what mistakes we make while building an emergency fund, or why we underestimate it so much. The first mistake is underestimating medical expenses. Let me give you some data on this. If we talk about insurance claims, then for the amount Let's say your medical expenses are ₹1 lakh at the hospital. You don't get 100% of that money back, even with insurance. Despite that, we have data showing you only get up to 58% back from insurance claims. So, if your expenses were ₹1 lakh, you might get ₹58,000 from insurance. But your out-of-pocket expenses would still be ₹42,000. That means we have no plan for that remaining 42%. In fact, we have more data on out-of-pocket expenses. If we look at private hospitals, the average medical out-of-pocket expense is around ₹500. This means, even with insurance, there are many needs for which we don't have funds, and that's why planning for them is necessary. The second mistake, when a requirement of this type comes to us, an emergency arises. Where do we go first? We go to our credit card or to personal loans. In fact, if we look at credit card data too, the number of credit cards issued, which was 33.8 million in 2017, reached 115 million in 2025, about 3.5 times. If we also look at the average transaction value on credit cards, it was ₹3400 in 2017, which became ₹4377 in 2025. Here too, there's a 1.3x jump, and it's not that this money is being spent only on our emergencies. All this money is being spent on electronic gadgets, being spent on travel. That is, we are giving more importance to many things besides our emergencies. Regarding emergency funds, most Indians aren't thinking about it at all. That's why we've created a four- The framework to build an emergency fund.
Step 1: What Is An Emergency
The first step is to define what exactly an emergency is, for which we need to create an emergency fund. This includes, for example, job loss. If you lose your job, or if your business income decreases. A medical issue can arise. There might be an urgent need within the family. So, all these are counted as emergencies. Within this, we should not include our lifestyle expenses. For example, if I wanted to buy a gadget, or if I wanted to plan a trip. These non-essential items should be kept away from the emergency fund. Essential expenses should be counted. Based on that, we need to build our emergency fund.
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Step 2: Count Essential Expenses
Now, what are these essential expenses? Like our rent, EMI payments, food and grocery bills, utilities, insurance, school fees, medicines are. Once you've listed your essential expenses, then you need to target building a 3-month, 6-month, or even a 9- month emergency fund based on these expenses. If your income is very stable, and you have no dependents, then you might be able to manage with just 3 months of your essential expenses for your emergency fund. But broadly speaking, for most people, 6 months is usually sufficient. We should definitely build an emergency fund of 6 months. However, if your income is irregular, if you don't receive the same amount of money every month, sometimes less, sometimes more, or if you have more dependents, or if your EMIs are high. Then in such cases, you should consider 9 to 12 months of essential expenses. You should definitely set a target.
Step 3: Where To Invest Your Emergency Fund?
So, once you've calculated your emergency fund amount, the next step is: where should we park this amount? Where to invest. For this, we can adopt a two-layered approach. Layer one money, meaning expenses for 3 months, we can put in an FD. You can deposit money. And here I would also recommend one thing to you: an auto-sweep FD account. Meaning, whatever money comes into your savings account, your salary comes in, you can put that into auto-sweep. It gets added to the FD amount over time. You keep earning FD interest. And whenever you need to withdraw money from it, you can easily withdraw it. For that, you don't need to go to the bank specifically to break the FD, or do any additional steps. But many people still can't maintain discipline here. So, for them, there's another way. You can start parking that amount in another account. Just put it in a different account. Every month, whatever amount we are saving, say 20-30%, whatever our monthly saving is, put it into a separate account where you do your FDs. can start putting it there. Then our second layer will be liquid day funds. So, whatever remaining money we have, whether it's for 3 months' expenses, 6 months' or 9 months'. Depending on how much fund you're accumulating, that money can go into liquid day funds. Now, what's special about liquid day funds? See, with FDs, we're already getting better interest rates than savings accounts. Plus, the liquidity is high there too. We can withdraw money anytime. The same thing is happening with day funds, and perhaps we'll get returns similar to FDs. But here, there's tax efficiency. Capital gains tax is applied here, whereas with FDs, normal tax is applied directly to our slab, added to whatever our total interest is. Although with day funds, there's also a slab rate The tax is calculated. But its capital gains calculation is quite different. So, tax efficiency, because we get better returns in debt funds, we can create a second layer for our emergency fund using debt funds.
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Step 4: Automate The Build
Fourth step: Automate the build. Meaning, whatever savings we need to make should be saved automatically. Whatever 20% or 30% you're saving each month should automatically go into an account or into a debt fund so that we don't have to think about it every month. That's why automation is very important in whatever investment we make. This is how our financial discipline is built. Now, understand, an emergency fund is not an optional thing. The first step of your financial planning is after your insurance. Just remember the purpose of an emergency fund is not to earn returns, but to have money available when needed. It needs to be available. For higher returns, we should invest for the long term.
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