Financial planning involves preparing for unforeseen emergencies and securing your future financially. An emergency fund is an integral part of any financial plan. Experts suggest having an emergency fund of at least three to six months of a family’s monthly expenditure. But remember this fund must only be accessed for unplanned scenarios or crises and not to meet routine expenses.
The article lists the importance of building a reliable emergency fund.
Need for an emergency fund
There are many situations where having an emergency fund can be helpful. For example, you may have an existing debt that you are trying to pay off. An emergency fund can come to your assistance to pay off the debt, meet unforeseen medical costs or address an urgent car repair. This way, you do not add new debt and have a cushion for unexpected expenses.
Understanding how an emergency fund helps
When a financial or medical emergency arises, without a financial backup, you may have to rely on friends or family for a loan. An emergency kitty can allow you to be financially independent and stress-free. It also saves you from breaking your existing investments such as fixed deposits or mutual fund investments. Typically, when you invest in mutual funds, you do so intending to hold them for the long-term for high returns and to build a large corpus. Breaking that investment can hamper the long-term goals you wished to achieve.
Size of the emergency corpus
Financial planners suggest the ideal corpus size of your emergency fund must depend on your monthly expenses, income, lifestyle, and dependents. As stated earlier, three to six months’ expenses can provide a sufficient cushion. The best way to build an emergency fund is to invest in debt funds for a short-term horizon either through a lump sum or SIP investments. You can invest in liquid funds or ultra-short-term funds that offer high liquidity allowing you to withdraw funds whenever you need them.
Returns from investing an emergency corpus
Rather than holding your money idle in a savings bank account, consider investing your emergency funds in mutual fund schemes that offer comparatively higher returns. With banks, you can expect a return between 3% and 4%, whereas by investing in liquid funds you can earn anywhere between 5% and 7%. Over the last one year, liquid funds and ultra-short-term funds offered an average return of 6.61% and 6.89% respectively.
An emergency fund can help you see through sudden financial emergencies. It is imperative to start saving to grow a sufficient emergency fund and invest it wisely. Mutual funds can be used to park your emergency corpus since it offers better returns and greater liquidity than most other options. You can read up more about debt funds and equity funds to create a balanced investment portfolio and reap maximum mutual fund benefits.