The ongoing coronavirus pandemic has hit India's economy hard, triggering a credit crunch for many. The calamity has made many people realise the importance of having an emergency fund. A contingency fund or an emergency fund is a specified amount set aside for emergencies that arise unexpected. These can be medical emergencies, temporary job loss, pay cut or unexpected travel due to family emergencies.
How to set an emergency fund?
For starters, the first step is to estimate how much money is required to meet any sort of emergency. Every individual has different financial needs. Hence, the amount will vary for all.
“Before calculating the amount of the emergency fund, it is important to calculate the minimum amount one needs to get through the unavoidable monthly expenses,” explains Harsh Jain Co-founder and COO Groww. This should include house rent, insurance premiums, loan installments, utility bills, groceries, etc.
According to Archit Gupta, Founder and CEO, ClearTax, an emergency fund should be enough to fund the monthly expenses for up to 6-8 months, or up to a year if an individual fear a job loss or feel things are uncertain on the financial front.
Where should one invest?
Emergency funds must be readily accessible; therefore investors should necessarily invest in liquid instruments.
Liquid instruments offer unhindered access to fund.
Gupta asks people to avoid accumulating emergency funds in equity-linked schemes as they are susceptible to market fluctuations.
“Since emergency funds are designed to cover emergencies, one shouldn’t let this corpus be influenced by volatility. Asset allocation, hence, should be done in debt and money market securities,” he explains.
Here are the options one can choose from:
People who are not comfortable with debt instruments can use savings account that offer a high rate of interest with no minimum balance requirements for parking emergency fund.
Flexible bank fixed deposits (FDs)
FD, being a secure investment, can also be used as an emergency fund investment. In any unforeseen requirement, fixed deposits can easily be converted to ready cash.
Investors can park around 30-50 percent of the investible corpus in liquid funds as they offer high liquidity along with better returns than a savings account, suggest Jain of Groww.
“By investing a sizeable part of the emergency fund in these schemes, liquidity is ensured since investors can redeem within a couple of days. Average returns on liquid funds hover around the 6-8 percent mark. With low risks and an opportunity to earn good returns, these funds can help in creating the corpus in a shorter period,” he elaborates.
One should consider starting a systematic investment plan (SIP) and automate savings and investments.
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