Recently I met one of my friends who met with accident and had to stay at home for 2-3 months. He has planned his investments in aggressive way in all high risk, high return investments such as Stocks, mid-cap mutual funds etc. and some of them are currently providing negative returns. He had to break some of such investments to have his living expenses to be taken care for next 2-3 months and booked loss in such investments. How many of us would have planned for our emergency fund? In this article, I would detail about how to build and manage your emergency fund.
Do we really need emergency fund?
Building an emergency fund is primary step to avoid any financial disasters because of unforeseen events and to prevent in financial stress in difficult times. In the fast paced life-style, financial emergencies keep coming. I would categorize the financial emergencies in two types.
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a) Unexpected expenses: You may have unexpected expenses in a month due to house repairs, car repairs or some unexpected education fees for you or to your children. While your credit card can save some of these emergency expenses temporarily upto 45 days, but still you need to pay back the money after this period.
b) Life warnings: There could be job loss / Layoff or expected accident to you or to your family members. While health insurance can save your hospital bills, if you are not doing your job for next 2-3 months and you are on Loss-of-Pay, it would be difficult to run your home.
Hence I feel, it is important that emergency fund is required so that you would not disturb your regular investments during such incidents.
How much emergency fund you may require?
You can consider 3 to 6 months of living expenses as your emergency fund.
Should I invest my next 3 to 6 month savings as emergency fund?
Plan to save your emergency fund over the next 9 months to 12 months period. This way, you would not feel that you are saving only for this purpose and you can concentrate on other investment options too.
Where to invest your emergency fund?
While you are investing your emergency fund, you should look mainly for safety and liquidity. You cannot invest in stocks or mutual funds or company fixed deposits as they involve some risk.
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a) Bank Fixed deposits: My first option to save the emergency fund is bank fixed deposits. I would also check about pre-mature withdrawal option and conditions. Several banks put restrictions about pre-mature withdrawals; hence consider this option where there are minimum penalties. The returns range between 8% to 9.5% per annum. However the returns are taxed.
b) Savings Bank Account: Another best place to invest your emergency fund is to keep it in Savings Bank account. There are several banks which are offering more than 6.5% per annum as interest rates for savings bank account like Yes Bank etc. I feel this would be a good option where you want to invest your emergency fund. You can invest upto Rs 150,000 in such Savings bank account and get interest up to Rs 10,000 which is tax free.
However while you invest in bank FD or savings bank account, your investment up to Rs 1 Lakh is insured under deposit insurance, hence you can break them into two deposits in two different banks.
c) Liquid Mutual funds: Another option to invest your emergency fund is liquid mutual funds. These mutual funds aim to provide good returns and provide liquidity. You can redeem such mutual funds within 3 to 5 working days and get your funds into your bank account. The returns are in-line with the bank FD’s.
Alternative investment options to invest your emergency fund
There are several alternative investment options to invest your emergency fund like Debt mutual funds, short term liquid funds etc., However, you should differentiate your normal investment with these so that you can redeem only relevant ones during emergency. However the returns are NOT guaranteed as you may take out the investment at any point of time. So you should prepare yourself not to expect any returns in case you want to withdraw such emergency fund from these options.
Conclusion: I am not saying that your priority should be to invest emergency fund. But in case of emergency, if you break your investments in stocks or in mutual funds, you may incur loss and your hard earn money would vanish. If you plan well, you can diversify your portfolio and invest part of your funds in investment options which I suggested and they can be used as emergency fund if required.
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How do you build, manage and invest your emergency fund
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Very useful information…
presently iam staying in UAE.I can save money up to 80k on every month .next two three years im planing to stay overe there.now im deposting in FD.can you please tell me where i have to invest for good returns ,I am ready to take moderate risk.
Rony, Since you are NRI, you can invest in stocks and mutual funds. Please refer my article on how an NRI can open an account. Since you are moderate risk investor, invest in large cap mutual funds and diverisifed mutual funds for 8 to 10 years. You can expect 11% to 15% annualised returns in long run. Please refer this article for top mutual funds. https://myinvestmentideas.com/2012/12/top-10-mutual-funds-for-sip-to-invest-in-2013/