Building an Emergency Fund with Mutual Funds

21 Jul 2018

What is an Emergency?

An emergency is a serious, unexpected and often dangerous situation requiring immediate attention. Situations such as loss of job, car/home repair, medical expenses qualify as emergencies in one’s life. However, vacations, shopping or requirement of any luxury product are strictly not emergencies. 

What is an Emergency Fund?

An ‘Emergency Fund’ or ‘Emergency Corpus’ or ‘Rainy Day Fund’ as the name suggests, is essentially a fund set aside to meet unexpected expenses and bridge financial shortfalls in times of crisis. This is the reason why an Emergency Fund must be liquid so that money can be withdrawn without any delay and penalty for early withdrawals. 

What are the Benefits of an Emergency Fund?

An emergency fund should be given more importance than investments and has to be built gradually over time. This fund offers various benefits 

1.Peace of Mind: An individual would have peace of mind as they are mentally aware that an Emergency Fund is readily available at times of sudden financial distress

2.Longevity of Long Term Investments: Emergency funds prevent one from breaking into their long term investments which may have been initiated for different goals in life

3.Habit of Saving: Emergency funds develops a saving habit and also helps to build financial discipline.

How to determine the size of an Emergency Fund?

There is no thumb rule with regards to the amount that needs to be set aside. Size of the Emergency fund purely depends on one’s lifestyle, monthly costs and number of dependents.  Usually financial planners advise to keep aside  4-6 months of expenses as an Emergency Fund. 

Where to invest in an Emergency Fund:

Though the Emergency Fund needs to be liquid, it is not something that one would be accessing often. Hence, it needs to be invested in a manner in which reasonable returns are earned. The ideal scenario would be to spread the funds across Debt Mutual Funds, Bank accounts & Cash. For instance, if you have Rs. 5,00,000 accumulated as your Emergency fund, you can roughly distribute it as follows

1.Debt Mutual Funds: 70%

2.Bank Account: 20%

3. Cash: 10%

Debt Mutual Funds:

Debt Mutual Funds mainly invest in a mix of debt or fixed income securities such as Treasury Bills, Government Securities, Corporate Bonds, Money Market instruments and other debt securities of different time horizons. Generally, debt securities have a fixed maturity date & pay a fixed rate of interest

The major reason for considering a Debt Mutual Fund as an emergency Fund is that it is very liquid

1.You can withdraw your investments at any time and the money is in your bank account the next day

2.Unlike a fixed deposit, the fund house does not levy a penalty for exiting soon

3.Some funds have an exit load if the investment is redeemed within 3-6 months

4.Most debt funds don’t levy a charge if the investment is redeemed after one month. Besides, you can make partial withdrawals, without having to break the entire investment.

Conclusion:

Disciplined financial planning and creation of Emergency Funds would help meet expenses at times of distress. With the maintenance of this fund, one need not borrow or loan money from the bank or family members and enter into a debt cycle. Hence, contact your wealth manager / advisor and find the ideal Debt Mutual Fund to invest in and secure your future. 

 

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