Save Smart. Where to park your emergency kitty

One aspect often emphasised for securing your financial future is building a contingency or emergency fund.

To protect your accumulated corpus earmarked for various goals, you need to save for unforeseen needs in advance. Job loss, medical emergencies or any natural calamity can be stressful, but can be managed if you stay prepared monetarily.

Typically, you need to have three to six months’ expenses as an emergency kitty. Add all your EMIs, monthly utility bills, grocery expenses, kids’ school fees and all other costs. To take a more conservative call, you can even add your monthly investments (SIPs in MFs, RDs etc). The sum will have to be increased suitably based on your outgo when you marry, have children, and so on.

But where do you park or hold these funds so that they are available on tap?

Liquid and ultra short-term funds

Parking your money in liquid or short duration funds would be optimal in terms of liquidity and the ability to earn more returns than savings bank accounts — and as much as FDs. Over the last one year, liquid and ultra short-term funds have given nearly 7 per cent returns and, in the last five years, they have delivered a healthy almost 8 per cent annually as a category. These funds invest in highly-rated debt instruments that mature within a very short duration, usually three to six months, and even overnight securities.

Being a market-linked products, liquid funds do carry an element of risk of erosion in their NAVs.

Funds houses such as Aditya Birla Sun Life, Reliance, SBI, UTI and DSP Blackrock offer instant redemption of units in their liquid funds.

You will be able to get the lower of ₹50,000 per day or 90 per cent of your folio credited to your bank account within minutes after you redeem units. This limit is for each fund house in whose scheme you hold units.

This facility is available even on non-business days and weekends. Therefore, these liquid funds truly cater to emergency needs.

If you need more funds than the allowed limit on an urgent basis, you can park amounts in multiple liquid schemes across fund houses, so that you can withdraw an additional ₹50,000 from each of them.

In case you need to fully redeem all your units, you will have to wait for one business day to get the proceeds.

If you remain invested in these funds and do not redeem for three years, the capital gains would be considered long-term in nature and taxed at 20 per cent with indexation. Short-term gains are added to your income and taxed at your slab.

You can invest in liquid funds through the SIP route and build your contingency fund over a period of one to one-and-a-half years.

Short-term FDs

The plain vanilla fixed deposits offered by banks can also be used to park emergency funds.

FDs are available from tenures as short as seven days. You can choose deposits that mature in a few months’ time, based on your requirements.

Interest rates offered by banks vary from 4.25 to 6.6 per cent for FDs of less than one year maturity.

But one main issue with these FDs is that they are not available on tap. You will not be able to break these deposits on public holidays or during weekends when banks are not working.

Also, breaking deposits ahead of maturity will entail penalties. Of course, penalties shouldn’t be a cause for concern in the case of interest earned on emergency funds. These FDs can be lower in your priority list for parking contingency funds.

Savings bank accounts

The trusted savings bank account, preferably with a sweep facility, can be a reasonably good option from the liquidity perspective. Interest rates, though, are low at 3.5-4 per cent in most cases. Some banks offer 6-7 per cent, subject to maintenance of balances.

If you have a sweep facility, you can earn FD rates on your funds and still have good liquidity.

For senior citizens, short-term FDs and savings accounts would be a bit more attractive as they have a threshold level of ₹50,000 on interest earned — only amounts earned in excess of this would be taxed.

Cash

In case of emergencies such as floods or earthquakes, ATMs may not function and there may be power outage, resulting in an inability to transact online.

During such times, payment for transport or ambulance or other emergencies may have to be done through cash.

So, you must have around 5-10 per cent of your emergency funds in cash. Don’t go overboard with physical currency, but you can have, say, ₹10,000-25,000 in the safety of your locker.