Emergency Fund – How to create, manage and invest in best investment options?
Emergency Fund – How to create, manage and invest in best investment options?
Life would not always go smoothly. There could be a situation where you need money in case of emergency. While Credit card can save to some extent for any unexpected expenses, if you can plan well, you can create and manage emergency fund without any problems. What is an Emergency Fund? What are various scenarios where you need to create emergency fund? Which are the Best Investment Options to invest Emergency Fund?
What is an Emergency Fund?
Emergency fund in simple term is a fund that would come to you handy when you are in need of money for any unexpected expenses. There are 2 categories in Emergency Funds
a) Short Term Emergency Fund
The emergency fund, which is accessible to you immediately within few hours when you need money. Since majority of credit cards are offering a high amount of credit limit, this has become less important nowadays.
b) Long Term Emergency Fund
The emergency fund, which is accessible to you within a few days when you need. This could be starting from 1 day to 5 days time frame. This is generally required after you utilize short term emergency fund.
What are various scenarios where you need an emergency fund?
You might need emergency funds for the following scenarios (not a comprehensive list):
1) Unexpected house repair
2) Unexpected medical expenses not covered under health insurance plans.
3) Unexpected car repairs (not covered under car insurance)
4) Unexpected education fees for your children (e.g. Planned for a free seat, but only paid seat available where you need to pay lakhs of rupees)
5) Job Loss / Lay-off where you may be idle for 3-6 months.
6) Your job requires you to move to a different location (relocation) where you might need additional expenses that are not payable by the employer.
How much Emergency Fund do you need?
There is no hard and fast rule here. This would depend on your current lifestyle and what emergency expenses you are planning for. If you are thinking that there could be a job loss and want to plan for emergency fund, 3-6 months of monthly expenses could be sufficient. If you have a 5+ year old car, thinking about un-expected repairs, Rs 50,000 (as an example) could be good. If you are thinking about your child’s education that you might incur, excepting such amount 2-3 years ahead can help you to plan well.
How to Create an Emergency Fund?
Once you know how much emergency fund you may need, you need not have such emergency fund on day-1. Let’s check various ways where you can create the emergency Fund in India.
1) Build Emergency Fund over a period of time
You don’t need to have an emergency fund on day-1. You can create / build this over a period of time. This could over 9 months to 12 month period (or lesser than that). E.g. if you need to have Rs 1 Lakh emergency fund, you can start saving Rs 10,000 per month and create this in a 10 month period.
2) Build Emergency Fund with Lump Sum + monthly savings
You do not want to waste your time building emergency over a period of time or you already have some money to start with. In such case, keeping some lump sum and building from there month on month could be a good idea. This method would help you to create an emergency fund faster and you can then concentrate on other financial goals.
E.g. You want to build Rs 1 Lakh emergency fund. You might have a lump sum amount, say Rs 50,000. In such case you don’t need to start from zero. You can start from Rs 50,000 and build up to Rs 1 Lakh. You can start investing Rs 5,000 to Rs 10,000 per month and build such emergency fund in 5 months to 10 months.
3) Build Emergency Fund immediately if you have already saved enough
If you are already well ahead in the game and have some savings already, your job is a bit easier. You can keep this money aside as an emergency fund and work on other financial goals and for long term wealth creation.
What Factors you should consider when investing your emergency Fund?
Here are the few pointers.
1) An emergency fund should be invested where you can liquidate / withdraw immediately.
2) Invest in investment option where there is no penalty or low penalty or low premature withdrawal penalty if withdrawn before the tenure.
3) Invest in a plan that has no exit load.
4) Invest in option that safeguards your capital and provides good returns.
Which are the Best Investment Options to invest Emergency Fund?
Once you have decided how you want to build your emergency fund, you might think where to invest the emergency fund now. You should keep in mind about short term emergency fund (that can be liquidated immediately) and long term emergency fund (that can be liquidated within 5 days) while choosing a good investment option. Here are few ways where you can invest.
#1 – Invest in Liquid Funds
I keep advising investors in several articles. One can keep their emergency fund in liquid funds. These liquid funds would provide the flexibility of investing online, liquidating on the same day and providing highest returns up to 7.5% per annum though not guaranteed. If you have invested only, say for 6 months you would still get up to 4% returns, though not guaranteed. Here are some of the Best Liquid Funds to invest in India.
i) Quant Liquid Fund – 1 Year: 7.5% returns and 5 years: 7.7% annualized returns.
ii) Franklin India Liquid Fund – 1 Year: 7.4% returns and 5 years: 7.6% annualized returns.
iii) Nippon India Liquid Fund – 1 Year: 7.3% returns and 5 years: 7.5% annualized returns.
iv) ABSL Liquid Fund – 1 Year: 7.3% returns and 5 years: 7.5% annualized returns.
v) Axis Liquid Fund – 1 Year: 7.2% returns and 5 years: 7.5% annualized returns.
#2 – Bank Fixed Deposits
One of the safest investment options to invest your emergency fund is bank FDs. You can open and close these Bank FDs online. Many bank FDs are offering higher interest rates up to 7.5% per annum. You can check the latest Bank FD rates here. There are pre-withdrawal penalty if you break them before maturity date. Consider investing in low penalty Bank FD schemes.
#3 – Bank Recurring Deposits for building over a period of time
If you are planning to build an emergency fund over a period of time say 9-12 months, you can consider investing in bank recurring deposits. You can open them online, get the highest interest rates up to 7.5% per annum and ease of closing them online in case of emergency.
You may like: Top 4 Short Term Mutual Fund Schemes to invest
Can we not invest emergency funds in equity mutual funds and debt mutual funds?
Some of the advisors are indicating investors to invest their emergency fund in equity funds or debt funds as they can always withdraw within 5 days in case of emergency. I would advise you to stay away for the following reasons:
1) Equity funds are high risk and provide handsome returns in the long run. The capital invested is high risk. E.g. if you invested Rs 1 Lakh, forget about returns, your capital itself would be at risk in the short term. In this case, do you still invest your emergency fund that can ruin your capital in the short term?
2) Debt funds have become high risk in the last 2 years owning to several scams / delay in payment of commercial papers of some of the corporates where mutual fund houses have been investing. You would have observed that your capital invested would have reduced in some cases. In such scenario, do you still invest your hard earned emergency money in debt funds?
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