How to build an emergency fund in 3 steps?

An emergency fund is the need of the hour. Emergencies come unannounced. The economic distress is spread wide and affected people from all walks of life. Job losses and reduced income have caused severe stress to families. Most people have learnt it the hard way and now understand the importance of having an emergency fund.

It is never to late to create an emergency fund. An emergency could come in the form of loss of income or health related problems. You are best placed to build a corpus when things are going good.

First Step – Identifying Essential & Non Essential Spends

The first step while building an emergency fund is to figure out their mandatory expenses. These are expenses that you cannot do without no matter what. They typically include groceries, utility bills, rent, EMIs and child care expenses. Segregate essential and non-essential expenses. Discretionary spends related to lifestyle like shopping, eating out and travel can wait.

Second Step – Starting Small & Using Supercharging Savings

Ideally, one should look to accumulate an emergency fund that can last 6 – 12 months of their mandatory/essential expenses. Starting small and having incremental targets help motivate you to save more and gradually build your corpus. Eliminating unnecessary spends will allow you to save more and accumulate the required funds at a faster pace. Using bonuses and cutting down on certain lifestyle expenses provide a booster to accumulate the required funds.

Third Step – Choosing the Right Instrument

The main criteria for choosing instruments for emergency corpus must be how quickly it available in an emergency situation. Investors should not consider other criteria like higher returns or tax benefits. By ignoring safety and liquidity, investors have learnt difficult lessons by parking in funds/banks which have seen trouble. For instance, RBI cancelled the license of CKP bank, a Mumbai based co-operative bank and have suspended operations of other co-operative banks. Let us look at few options to build your emergency corpus;

Cash

Nothing beats the convenience of cash. You just have to dig in take the cash and make payments. This holds good if you cannot access your bank in an an emergency situation. Like all things in life, this too holds good in moderation. Too much of cash lying around can be risky.

Savings Bank Account & Flexi-Deposits

Your savings bank account is a good place to store your emergency corpus. You can use your debit card or just go to the bank to withdraw funds to make the necessary payments. One can look at Flexi-Deposits that transfer excess funds from your savings accounts above a threshold to a fixed deposit that yields higher than savings bank accounts and are accessible easily. It is important to not go after co-operative banks in search of higher returns.

Liquid Mutual Funds

Tax efficiency is a major concern when choosing savings and fixed deposits. Mutual Funds help you address this issue to a large extent. The gains are not taxed immediately and you get indexation benefits if you hold on to these for more than 3 years. But these are not completely risk free. The recent events around debt funds in India has put doubts in the minds of investors and experts. For emergency corpus it is better to restrict to large Liquid Funds, get help of a fee only financial planner to choose a liquid fund which invests primarily in sovereign and AAA rated papers.

Investing in funds that have Instant Redemption Feature will allow you to redeem up to ₹ 50,000 or 90 per cent of the portfolio value in liquid funds across folios under a permanent account number (PAN) per day. The funds normally reach your bank account within 30 minutes. For example, if you have ₹ 1 lakh in a liquid fund offering instant redemption facility, then you can withdraw ₹ 50000 on a given day, as the amount satisfies both the conditions – maximum limit of ₹ 50000 and it is below 90 per cent of the investment amount. But if you have a balance of ₹ 50000 in your liquid fund, then you can withdraw a maximum ₹ 45000.

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