Starting an Emergency Fund? Here are 3 Things to Keep in Mind
Important features to look for before starting an emergency fund.
Recently, we talked about emergency fund and how to build a basic one for a rainy day. Ideally, it should be able to cover your fixed and variable expenses for a specific period of time – 3 months, 6 months, 12 months, 18 months or 24 months. But do you know how to choose the right option to park your money and what to look for?
Here are 3 features of an emergency fund:
- Ease of Access: The most important feature of an emergency fund is that you should be able to put the funds in and take them out easily. This is simply because in an emergency, the last thing you would want is to complete formalities and wait for a long time to get the funds. This means it is a good idea to avoid time-based deposits like long-term fixed deposits or fixed-tenure bonds
- Safety: The second feature that matters is that it should be a risk-free option. When you want to build wealth, you may have to invest in assets that come with moderate risk. However, your funds for contingency should be parked in a safe place that ensures your capital stays protected. Something like short-term (1-month or less) fixed deposits, liquid funds that invest in government bills, etc. and which allow you to access the money within a week at most are good bets. It also makes sense to keep at least a month’s worth of living expenses in a savings bank account that you do not access regularly
- Assured Returns: Unless you are building an emergency fund in cash, it would be ideal to get assured returns on your investment even if it is low or moderate. A fixed deposit, high-interest or standard savings account and so on are some of the easily accessible options for everyone. A scenario can be to have 1-month living expenses in a savings account, another couple of months’ expenses in short-term (1-month or less) fixed deposits or liquid funds, and the rest in debt mutual funds. Putting all the money in a savings account may not make sense as the interest rate you get on savings accounts (3-4% on an average) is less than the historical inflation rates (last 20-year average historical inflation rate hovers slightly below 7%)
If you are putting your money in a short-term investment plan, you ought to check for any penalties on premature withdrawals so you can access your own money without too much of a hassle.
So, what would you look for when looking at emergency fund investment options? Share your thoughts with us.