An emergency fund is a necessary corpus that you must set aside to deal with emergencies. It is a fund to which you can turn in times of crisis or for unexpected and unplanned scenarios, not for meeting your regular expenses. As a result, you must tailor it to meet any unexpected financial shortfalls that may arise. The ability to cover unexpected expenses is the reason why an emergency fund should be liquid; this is the most important factor to consider when deciding where to park your emergency fund.
You should be able to withdraw the funds as soon as you need them. At the same time, you must avoid being penalized in the form of an exit load or a pre-withdrawal penalty. The value of the investment in share market should not fall and should provide excellent returns. An emergency fund is not built overnight, but rather over time. Set aside a certain amount each month in a separate bank account. It will soon grow into a sizable corpus that you desire. Assume you’ve decided to set aside Rs.2 lakh for an emergency fund. In this case, you can set aside Rs.10,000 or Rs.20,000 each month to build up the necessary corpus.
An emergency fund can be three to six months of your monthly income, depending on your income and expenses. You could even divide your emergency fund into two categories.
Long-term emergency fund:
This is where you put money aside for large-scale emergencies, such as a major natural disaster or an unexpected medical emergency. This fund should be invested in instruments that pay a slightly higher interest rate but may take a few days to liquidate.
Short-term emergency fund:
This is the fund you go to in an emergency. Such a fund should pay little interest but provide immediate access, which in extreme cases can suffice until you can access your long-term emergency funds.
Investing your Emergency fund:
Once you’ve accumulated an emergency fund, you shouldn’t leave it entirely in cash or in a bank account. Even though an emergency fund should be liquid, it is not something you should have access to on a regular basis. As a result, invest it in such a way that you can earn decent returns while maintaining liquidity. The best course of action would be to distribute the emergency fund among liquid funds, short-term RDs, and debt mutual funds in India.
A liquid fund is a type of debt fund that invests in debt instruments with maturities of less than 91 days. These debt instruments are high-quality paper that is unaffected by interest rates. As a result, they earn respectable returns while remaining stable. Liquid funds have earned returns of up to 8% in recent years. These are higher returns than you would receive from a savings account or a fixed deposit. If you don’t need this emergency fund and stay invested in the liquid fund for more than three years, you’ll even benefit from indexation when it’s time to redeem.
In terms of liquidity, many liquid funds allow for instant redemption of up to Rs.50,000, or 90% of the invested amount. You have the option to redeem at any time. They will immediately credit the funds to your linked bank account. Check for this option before investing in a liquid fund to ensure that the fund house allows it. This way, by distributing your emergency fund across multiple channels, you can ensure quick access while reaping high returns. Tradeplus can help you find the right investment vehicle to invest your emergency fund.