What are emergency or contingency funds for?
Many a times in life there are situations where you need money immediately. For example, if you lose your job, if your car breaks down or suffers a major accident and needs to be repaired, if you or a family member need to be hospitalized, or you need to travel urgently. At such times, you need cash immediately often in a day or two. To meet these needs, you either need to borrow or have your own kitty kept aside. Financial planners suggest building an emergency fund, which is a stash of money, kept aside to cover such situations.
What is the benefit of having emergency funds?
Having an emergency kitty ready, serves the purpose and saves you from taking a loan from friends or relatives. It also saves you from breaking into your investments such as equity mutual funds or long term investment products done to meet a particular long term goal. Being prepared with an emergency fund gives you confidence you can tackle any unexpected events without worries. It also inculcates a savings habit rather than spending cash frivolously.
How big should an emergency fund be and how can you build one?
Financial planners believe you should have atleast 3-6 months worth of expenses as an emergency fund. 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 lumpsum route. Windfall gains be it annual bonus, can be used to create this corpus. Investment can be made in liquid funds or ultra short term mutual funds. These funds enjoy easy liquidity. In case of an emergency or when one needs money, investors can redeem within 1-3 working days.
How much can you earn in liquid or ultra short term funds?
Rather than keeping your money idle in a savings account where you earn 4 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 7.05 per cent, while the ultra short term funds category has given 7.97 per cent.
Source: Economic Times