What is an emergency fund?
How big should it be?
Where should you keep it?

If you earn ₹50,000 monthly and ₹35,000 of that goes into meeting all your expenses, then your emergency fund should be something between ₹4,20,000 (₹35,000 multiplied by twelve).

An emergency fund should be big enough to cover the unavoidable expenses like existing EMIs, daily household expenses, children’s tuition fee, utility bills, expenses on medicines, insurance premiums, etc. for at least 6 months. For those having lower income or job certainty, this fund should be able to cover these expenses for at least 12 months.

For example, a double-income family with Rs 50,000 monthly expenses should have emergency funds for six months of expenses (Rs 3 lakh). A single-income family with the same monthly expense needs 10-12 months of expenses (Rs 5-6 lakh) as an emergency fund.

If you have taken a loan, increase your contingency fund accordingly to cover loan repayments. Once you have repaid the loan, decrease the size of the fund. Avoid parking your contingency fund in instruments which don’t offer easy liquidity or have a lock-in requirement

One important thing to remember while calculating your monthly expenses is to consider EMIs and insurance premiums that need to be paid.

Since your emergency funds need to be invested in minimal-risk instruments, you have multiple options – your savings account, recurring deposit (RD), fixed deposit (FD), debt mutual funds such as an ultra short-duration fund or liquid funds.

Savings account: If you choose to use your bank savings account to maintain emergency funds, you need to ensure that you are disciplined enough not to withdraw and spend your money except in the case of an emergency. This is difficult unless you have a separate bank account to park your emergency funds.

Recurring deposits: Alternatively, using a recurring bank deposit (RD) to save emergency funds will give you slightly higher returns, 4% to 8% p.a. However, if you withdraw your recurring-deposit investments prematurely, you will have to pay the penalty, which can decrease your overall returns from the investment. Plus, the interest from bank RDs is fully taxable as per your income-tax slab.

Fixed deposits: You can earmark an existing FD as your emergency fund, or if you already have a lump sum, you can invest it in an FD. You can earn higher returns this way based on the FD tenure but do remember that FD returns are taxable as per your tax slab. Plus, if you prematurely break an FD, that could entail some penalty as well.

Liquid funds: Liquid funds are the best way to build an emergency fund. These debt funds invest in bonds with maturities up to 91 days. Liquid funds are low-risk, and at the same time, you get a chance to earn higher returns than a savings bank account. Being a debt fund, they also have favourable taxation. If you sell a debt fund after three years, your gains are termed as long-term capital gains and they are taxed at 20 per cent post-indexation. Indexation adjusts the purchase price as per inflation, thus reducing the tax liability.

Ultra short-duration funds: Compared to bank fixed deposits with an equivalent or analogous investment tenure, ultra short-term funds typically offer comparable or slightly higher returns. Plus, if you hold the investments for over three years, you have a tax advantage compared to bank RDs, as explained above.

Moreover, like liquid funds, ultra-short-duration funds are highly liquid, ensuring you can easily access your funds in an emergency without paying any penalties.
You can opt for regular investments in these funds via a monthly systematic investment plan (SIP) to build your emergency corpus. However, do remember that returns from debt funds are not guaranteed like bank RDs or FDs.

#emergencyfunds #finance #justify #business #money #investing #investingtips #investment