What Is a Reserve Fund and How Does It Work?

As the name suggests, reserve funds are a pool of money that an individual or organization has saved specifically to meet unexpected expenses that may crop up anytime in the future. Financial advisors worldwide suggest that having a reserve funds pool is essential for efficient financial planning. 

How do reserve funds work?

The reserve funds are also commonly known as contingency or exigency funds, and it comes in handy during an emergency. Apart from emergency use, you can use such funds for large, planned expenses. However, for the reserve funds to be available whenever you need them, you must build your savings over time and keep depositing or investing a small sum periodically in your reserve fund pool.

One of the critical things to know about reserve funds is that they must be held in a liquid asset, such as a savings bank account or a savings plan, so that you can easily access the fund when a contingency emerges. 

How to build reserve funds?

Reserve funds must be equipped with enough cash to deal with emergency expenses that may spring up anytime. The size of the reserve fund you hold would depend on several factors like how much money you set aside from your monthly income towards such funds, the period since you start saving, and how financially disciplined you are. 

So, to ensure that you have enough funds, it is advisable to start saving early and building the reserve funds as soon as you get your first salary. The key to building a large reserve fund is to be systematic and open a different bank account. Maintaining a separate account will make it easier for you to keep track of the money you deposit and withdraw over a period. 

Building reserve funds is not just about saving money but also investing in smartly so that you can let your money grow faster yet have access to it when needed. There are many savings plans in India that provide valuable returns. You can consider investing in government-backed schemes like NSC (National Savings Certificate), PPF (Public Provident Fund), FD (Fixed Deposit), RD (Recurring Deposit), etc. 

You must know that these investment plans may have a lock-in period, which means you cannot withdraw funds for a specific period. You may have to pay premature withdrawal fees if you withdraw during this period. 

It is paramount that you have a proper strategy for how you want to utilize these funds. Make sure that you withdraw or use these funds during an emergency only. Also, never withdraw more funds than you need. When you withdraw money from the reserve funds, ensure that you deposit the amount back in the account at the earliest. 

Another effective way to build a sizeable reserve fund pool is to be conservative and smart with your budgeting. When you spend a significant sum, ask yourself if the expense is necessary or unavoidable. You can redirect the amount to your reserve funds if it is not. Make a fixed budget for different household expenses and try to stick to the budget so that you avoid overspending and compromise on your savings and contribution to reserve funds. 

If you think you are not able to build enough reserve funds with your income and are barely able to spare every month after meeting your regular expenses, you can try looking for a secondary income source. You can try taking a part-time job for a few hours every week and divert the additional income towards reserve funds. 

Final Word

Reserve funds are vital to get over financial emergencies. When considering how much money you should deposit in your reserve fund, saving at least 10% of your annual salary towards reserve funds is advisable. Any additional bonus or surplus income you get in a year, transfer the same to your reserve fund so that you can set up the funds faster.