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Building an emergency fund with mutual funds

If an emergency arises, one would have to take a loan or borrow from family or friends. This is not a situation which many of us would like to get into.

, ET Bureau|
Aug 01, 2019, 09.43 AM IST
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Emergency fund
Financial planners believe every investor should have an emergency fund the amount of which could be equal to 3-6 months of his monthly expense. One of the ways in which an investor can build this corpus is through mutual funds.

Why do you need an emergency or contingency fund?
There may be many instances when there is an immediate need for money. For example, a job loss, a car breakdown or accident, a health or hospitalisation issue with your close ones or urgent travel could mean you may need cash in a short notice. To meet these needs, you either need to borrow or have your own kitty kept aside. Financial planners suggest building an emergency fund, which helps you take care of such situations.

What are the advantages of having this fund?
If an emergency arises, one would have to take a loan or borrow from family or friends. This is not a situation which many of us would like to get into. Having an emergency kitty ready saves you from doing this. This also saves you from breaking into your investments such as equity mutual funds, shares or long-term investment products which have been done with an objective to meet long-term goals. Being prepared with an emergency fund gives you confidence you can tackle life’s unexpected events without worries. It also inculcates a savings habit rather than spending cash frivolously.

What is the ideal size of the emergency corpus?
The size of the fund, believe financial planners, depends on your lifestyle, monthly costs, income, and dependents. A general rule of thumb says it is wise to put away at least three to six months’ worth of expenses. They suggest using debt mutual funds as the best way to build this corpus. Investors can build this slowly or over a period of time. They can use either the systematic investment plan (SIP) route or the lumpsum route. Cash received through windfall gains can be used to create this corpus. Investments can be made in overnight liquid funds or ultra short-term mutual funds. These funds enjoy easy liquidity and investors can earn more than they earn in a savings bank account. In case of an emergency or when one needs money, investors can redeem within 1-2 working days.

What can one earn by parking money in these funds?
Rather than keeping your money idle in a savings account where you earn 3.5 per cent paid by banks, investments in liquid and ultra short-term funds, tend to offer you higher returns. As per data from Value Research, over the last one year, the liquid funds category has given an average return of 6.87 per cent, while the ultra short-term funds category has given 6.16 per cent.

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