You may have heard the adage ‘change is the only constant’ far too many times. Truly, uncertainty in life is inevitable. However, uncertainty has assumed a whole new meaning with the onset of the Covid-19 pandemic. In this backdrop, we have also seen an increasing number of emergencies of various kinds, be it of a medical nature or financial. What we have learnt over the last year is that uncertainty is here to stay, but we can surely protect ourselves as much as possible when it comes to these exigencies by having an emergency fund at our disposal.
An emergency fund is money kept aside to cater to any form of unforeseen circumstances. Emergencies may be short-term or long-term in nature. Short-term emergencies may include unexpected travel or sudden illness or injury when uninsured. Long-term emergencies may include chronic illness while being uninsured, a long break from work, and so on. Be it any kind of situation, an emergency fund can help you retain your peace of mind. It can not only help you fulfill your financial obligations in times of need but also keep your long-term investments on track.
It is recommended that you keep expenses for3 to 6 months for the short-term and 6 to 9 months for the long-term in your emergency fund.
But, while the money is being kept aside, wouldn’t you rather deploy it to earn some returns?
Let’s explore some investment options for deploying these funds.
Where Should You Keep Your Emergency Funds?
Bank savings account: One of the most popular options for parking emergency cash remains the bank account. Your savings account typically yields a relatively low interest; however, it is also highly liquid. You can access your account 24/7 and get your money immediately. Therefore, it makes sense to keep cash for short-term emergencies in a savings account. However, it does not make sense to keep your entire emergency fund in the savings account as there is scope to earn relatively better returns through other instruments.
Fixed Deposit: Fixed Deposits typically offer better interest rates than a savings account. Keeping your money in an FD, however, is subject to a lock-in. Of course, you can always liquidate your FD whenever you want, however, that may entail a premature withdrawal penalty and even interest revision in some cases. One option you can explore here is the “sweep-in” facility, which allows your bank to automatically transfer any amount that is in excess of a threshold determined by you from your savings account to a sweep-in fixed deposit.
It must be noted that interest from both savings account and FD are subject to taxation as per income tax slab rates.
Liquid Fund: Another option to park your emergency fund is in liquid mutual funds. These funds invest in debt instruments with less than 91 days maturity and high credit quality. Liquid mutual funds offer the scope of slightly higher returns than traditional avenues like bank accounts and FDs. Further, these funds can be easily redeemed in most cases as most fund houses offer the instant redemption facility – which allows for 90% of the total holding or Rs.50,000 to be redeemed instantly. The risk involved in liquid funds is slightly higher than in FDs and savings account. However, any redemption within seven days of investment will attract an exit load.
Gains from liquid funds are taxable, however, if you remain invested for more than 3 years, you are eligible for the indexation benefit.
So, which is the best investment avenue?
When it comes to parking your emergency money, while it is best that you spread it across different avenues rather than keeping it in one single place, you also must ensure that your money is giving you the best returns possible. To make the most of your emergency fund corpus, you should consider parking your emergency fund in liquid funds. Liquidity funds work just like your bank account and offer the same liquidity at comparatively higher returns. They also have additional tax benefits as mentioned earlier. Liquid funds, therefore, score higher than bank account and FDs as an emergency fund avenue. The topic of emergency funds is especially relevant in the ‘new normal’ of unexpected lockdowns, pay cuts, widespread unemployment, and medical emergencies. What better time than to start now? Build your emergency fund and invest today!