One of the most important aspects of sound financial planning is setting aside expenses for 3 to 6 months for emergencies. One of the easiest ways to create such a corpus for an emergency is via mutual fund (MF) investments.
Life is often unpredictable and many of us usually come across situations that require emergency monetary solutions. You may urgently need money to take care of sudden hospitalization or house repairs due to a disaster like a fire or a flood. Money is required to come out such unfortunate events. Financial experts believe that it is sound financial practice to send some money aside to meet such unforeseen requirements.
The advantages of having a readily liquid contingency fund
If you do not have created a contingency fund, then you may probably have to borrow money from friends or family, or you may have to take out a personal loan to be able to meet emergency expenses. A stash of emergency money helps you avoid this. It also helps avoid you breaking certain long-term investment options, like fixed deposits or equity mutual fund investments, that help save for future financial goals.
The presence of an emergency fund also makes you more confident of your financial security and less afraid of any possible unfortunate emergency situations in the future. You tend to remain free of stress and get more joy out of life.
Saving an emergency fund instills in you the habit of saving. It also prevents you from reckless shopping sprees, unnecessary spending, etc.
How to create an emergency fund and what should be its size?
The size of the contingency fund is dependent on your monthly expenses, lifestyle, number of dependents, and income and can vary accordingly. The underlying rule however is that you save sufficient emergency money needed to meet the predictable expenses for 3 to 6 months.
Financial experts and planners are of the opinion that the best manner to create such an emergency corpus is via investments in debt based mutual fund schemes. The fund can be accumulated and built up gradually over a period of some years. You may invest a lump sum in debt mutual funds or you may opt for the SIP (systematic investment plan) route, wherein you put away a certain amount of money into the debt MF portfolio every month. Such funds can be easily liquidated as and when needed. Thus, if there is an unfortunate emergency or if you are in dire need of some cash, then the debt MFs can be redeemed by you in 1 to 2 business days.
What are returns on investments in ultra short-term funds or liquid funds?
A savings account in a bank typically offers an interest rate of 3.4 percent per annum. Instead of keeping your money lying wasted and idle in such accounts, it is a better option to put them to work and make more money. You will get increased returns by investing that money in ultra short term and liquid funds.
It may be noted that the category of liquid funds has offered all its investors an average return of nearly 7 percent over the past year. Comparatively, the category of ultra short term funds has offered returns of just over 6 percent over the past year.