Having an emergency fund is a critical element of any financial plan. It is basically an account that can provide you with a financial cushion in case of a job loss, medical emergency, necessary vehicle repairs, or any other unforeseen circumstances without going into debt or dipping into your long-term investments. But how do you create an emergency fund that is easily accessible in times of need? The answer is liquid funds.
Liquid funds are debt mutual fund schemes that invest in high quality short-term instruments including treasury bills, commercial paper, certificates of deposit and government securities that mature within just 91 days. When compared to a regular savings bank account or fixed deposits, liquid funds tend to offer higher returns, so you can build your emergency fund faster to be financially covered in case of any sudden expenses or income interruption.
Read on to learn how you can use liquid funds to park your surplus and maximise your emergency fund savings.
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Determine your emergency fund amount
Before investing in liquid funds, it’s essential to establish your emergency fund amount. The general rule of thumb is to have at least six months of living expenses set aside. This is because it takes time to adjust when unexpected circumstances arise, so having multiple liquid funds can help reduce the strain caused by sudden changes in income or unexpected expenses.
However, the amount you need might vary depending on your lifestyle and the number of dependents you have. For example, if you have a partner who works or two sources of income, your emergency fund requirements could be less than six months.
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Set aside 10%-15% of each pay cheque into a liquid fund solely for emergencies
The key to building an effective emergency fund is setting aside money regularly. Try to set aside 10-15% of each pay cheque into a liquid mutual fund solely for emergencies. This will ensure that you always have cash on hand when you need it most. Make sure to review your budget regularly and adjust your mutual fund investment strategy accordingly to continue contributing without overspending or going into debt.
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Invest in high credit rating securities
Investing in liquid mutual funds can be low risk, but just like any other investment, there is still some risk involved. It is crucial to choose funds that invest in high credit rating securities as they indicate a low risk of default. Look for funds that invest in AAA, AA rated securities, which can help you earn slightly higher returns while ensuring safety.
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Diversify your mutual fund portfolio
It’s crucial to maintain a diversified portfolio even when investing in liquid funds. Investing in a single liquid fund may expose you to more risks. Hence, invest in multiple liquid funds that invest in different securities. It will help you spread the risk, and in case one fund underperforms, you will have others to offset the losses.
Final words
Liquidity is a key factor in creating an emergency fund and with liquid fund investments, you can ensure that you have access to your money when required. Generally, the redemption request of liquid funds is processed within one working day or T+1 day. However, mutual fund houses have introduced instant redemption of up to Rs. 50,000 for these funds also. This allows the investors to withdraw their money anytime and receive it in their linked bank account instantly.
It is equally important to ensure that you buy mutual funds by carefully researching its objective, past performance, credit quality, and expense ratio. Having this information is crucial for creating an effective emergency fund, one that can be relied upon during periods of financial hardship.