American mathematician John Allen Paulos once remarked, “Uncertainty is the only certainty there is, and knowing how to live with insecurity is the only security.” Uncertainty in life typically comes in the form of job loss, medical emergency, and unanticipated travelling.
Such events are inevitable and unexpected, and can weaken one’s economic health. Traditionally, money required for a rainy day was kept in bank deposits (fixed and savings).
However, with falling interest rate and inflation eroding the purchasing power of money, mutual funds appear more appealing. Read on to understand how to build an emergency corpus with the help of mutual funds.
Key Aspects of an Emergency Fund
Explore Mutual Funds to Build an Emergency Kitty
Short-term maturity debt funds such as liquid, ultra-short-term, overnight, money market, and low duration funds are a good investment avenue to help build an emergency corpus since they are relatively less risky among all other categories of mutual funds, and score high on liquidity and returns. Investors can start investing in these funds either via lump sum investments or a systematic investment plan (SIP)
Some of the key variants and features of short-maturity debt funds are:
Note: * Macaulay duration is indicative of the sensitivity of the fund’s portfolio to the change in interest rates. Funds are defined as per SEBI’s classification
Here’s a theoretical example: Swapnil wants to build an emergency fund wherein he can easily withdraw money as and when needed. He has two options – traditional savings bank account or a short-term debt fund. For this analysis, we have looked at liquid funds, one of the more popular avenues for parking money in the short term.
The money invested by Swapnil (assumed at Rs 2.5 lakh) would have generated just 4% returns in a year versus 7.11% by investing in a liquid fund. Even if we compare post tax returns from both the investments, liquid funds’ returns still top the traditional investment avenue (see the table).
|Particulars||Savings account||Liquid fund|
|Taxation @ highest tax bracket||NA||30%|
As indicated, investments in short-term debt funds are more enriching than in the traditional products. However, debt funds are exposed to market risks (interest and credit) and do not offer guaranteed returns like bank deposits. Investors can allocate a portion of their portfolio to these funds and capitalise on professional management and the ability to get better returns.
Emergencies turn up without a warning, but we can be prepared well in advance. Befriend mutual friends to build a contingency corpus. Before choosing the right fund, do conduct due diligence on portfolio attributes, costs such as exit load, track record of the fund house, and invest as per your risk profile.