Money means different things to most people. For some, it is about doing well in life while for others it is about a sense of security that whatever comes can be tided over. However you may look at or think about money, some concepts remain universal in their need and applicability. Creating and maintaining a sufficient amount of emergency funds, even while in pursuit of long-term patient investing through risky assets, is one such act.
What is an Emergency Fund?
Today, most of us understand the need for a life insurance, which is an essential product to cover in case of the worst kind of permanent emergency scenario. However, apart from such extreme situations, there are enough and more types of short term emergencies that are often tided off easier in case of some money to see it through. These could be as small as home or car repair or a longer struggle like a job loss. When such unseen emergencies trip you in your journey of life, having enough liquid, easily accessible money is something that can cushion the blow.
It is easy to succumb to the temptation of spending it all in the quest of instant gratification or to make all your money work harder through the route of equities. However, an emergency fund is like the engine oil that will help your car run smoothly, even on uneven surfaces.
Having a consistent emergency fund that can cover atleast 6 months of your expenses is a smart financial planning habit. If you feel uncomfortable unless there is a certain higher amount in easy access, know where to draw the line and maintain that as your bench mark.
Why do you need an Emergency fund?
Sometimes, it can seem like a waste to just have that money stashed up with nowhere to go. However, in the long run, there are many benefits to having an emergency fund. Let me list down three here.
Mental peace of mind
Life has surprising ways of testing us. Most of those tests get further complicated, if we add dearth of money to the equation. Money is a tool that is supposed to make us feel better and life smoother. Having an emergency fund helps us do just that, in times that we need it the most.
While a lot of us pride ourselves on our investing discipline and like to watch our money grow, growth financial assets are not perpetually suited for withdrawal. Case in point being a time like today. If you have invested keeping a longer horizon in mind while averaging your cost with multiple entry points through the routes of SIP or STP, then you are on the right track. However, in such a time when the markets are not very favourable, and you end up being in sudden need of money, such assets could need to be redeemed, even at a loss. In case, you have piled in all your savings into real estate, as an asset that is even more illiquid and not conducive for any sudden requirements of money.
No interruption to long term financial goals
This is one of the most important, yet often ignored reason to have an emergency fund. When you come up with an emergency situation, requiring quick funding, in the dearth of an emergency fund, you will end up having to withdraw from other investments which might be earmarked for other long term financial goals. Derailing those plans comes at a cost of either downsizing your financial goals or having to cover up for that interruption. Having an adequate emergency fund means your long term financial goals can continue growing and thriving uninterrupted.
Best assets to park an Emergency Fund
Most Indians prefer parking their money in savings accounts or Fixed Deposits when it comes to a secure stash. However, post taxation and taking into account inflation, you could end up eroding the real value of money in Savings Accounts and being right on the line with Fixed Deposits too. Today, despite being market linked, there are a few options that offer liquidity, safety and better returns.
Most investors who have some experience of the markets, are aware of the merits of parking money in a liquid fund for easy accessibility. Liquid funds are a category of debt funds that invest in very short term papers. In more understandable language, liquid funds lend money which is to be repaid in a matter of less than 3 months. In fact, the average maturity of the debt papers in liquid funds mostly tends to be lower than 45 days. Considering the short maturity period, it makes them less vulnerable to credit default or the risk of not being repaid as well as interest rate volatility.
Liquid funds offer better flexibility than Fixed Deposits since you do not need to define a period of investing. The best part is that there is no exit load. So even after investing, at any point redemption can be done without a penalty. In a situation, where you end up staying invested for more than three years, then you also get the benefit of indexation and a 20% flat tax on the capital gains, leading to much higher real returns than Fixed Deposit at a marginally higher risk.
Ultra Short Funds
Ultra Short funds are very similar to Liquid Funds, with the main difference lying in the fact that they lend for slightly longer periods, mostly in the range of 3 – 6 months. This ends up with 1-1.5% higher returns annually. So, in the last one year, most funds in this category have given a return in the range of 8% – 9%. The risks of investing in liquid and Ultra Short funds are pretty similar. So, in case you don’t see a need for funds in the immediate future, you could consider this with the expectation of a higher return than liquid funds, yet being relatively safe.
This category is the safest possible equity mutual fund. Arbitrage or specifically Equity Arbitrage funds work on the principle of mispricing of one asset across different markets.
For instance, at day closing on 27th August 2019, TCS stock price was 2241.50 on NSE and 2237.00 on BSE with an absolute difference of Rs. 4.50. This is just one instance but the fact remains that one asset can be priced differently across markets. These funds take advantage of that mispricing and make gains on that basis.
Unlike debt funds, the returns do not vary with the interest rate in the economy or the MCLR. Rather, the returns are pretty stable in the range of 6 – 7%. Shocked? Yes, the gross returns are lower than liquid or ultra-short funds. However, they tend to be safer as they do not depend on possibly faulty credit ratings or the repayment ability of the borrowing entities or even the prevailing interest rate in the market.
But, the biggest clincher in it’s favour is the fact that it is taxed as Equity! So, the short term is a mere one year long as compared to three years in debt funds. Even in that short term, gains are liable to be taxed at 15% unlike the income tax bracket rule followed for debt. More importantly, in the long term of more than one year, your first one lakh of gains are tax free with the remaining gains being taxed at a mere 10%.
When you compare real returns and the risk quotient, these three options work out well to have your money easily accessible and liquid while growing to be slightly better off than the erosive effects of inflation.
Moneyfront now also provides you with an option of InstaCash – which is a liquid product with instant redemption facility. Money invested through this feature could be redeemed even on a Sunday and credit to bank happens instantly via IMPS. Check out the InstaCash, liquid funds, ultra short funds and arbitrage funds on Money Front today to see the various options available and decide on where to park your emergency funds today.