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A crucial roadmap for establishing an emergency fund

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Financial stability is a goal that resonates with investors worldwide. In India, as in many other countries, the concept of an emergency fund plays a pivotal role in achieving this stability. However, unlike traditional investment avenues, most Indian investors are reluctant to park their emergency funds in savings accounts, where the returns are minimal. This article shall elaborate on the significance of an emergency fund, the strategies for building one, and where investors can grow their emergency fund for better returns.

Why must investors have an emergency fund, and what should its size be?

Life is unpredictable, and it often throws unexpected challenges our way. During a sudden medical emergency or an unforeseen financial crisis, investors can benefit by having a financial safety net in the form of an emergency fund. 

  • In the case of a medical emergency. Hospital bills, surgeries, and medications can lead to substantial expenses that are often not covered by insurance. In such situations, an emergency fund can be a lifesaver, helping investors access the required funds without delay.
  • Additionally, in the situation where the investor loses their employment or faces a sudden reduction in income. Without a financial cushion, an investor may find it difficult to cover their monthly expenses, such as rent, utilities, and EMIs (Equated Monthly Instalments). An emergency fund provides investors with instant access to liquid cash, allowing them to weather such financial storms with ease.

What could be termed as a sufficient emergency fund amount? 

A common rule of thumb is to have an emergency fund that can cover three to six months’ worth of essential expenses. Investors must list their monthly financial obligations to calculate their emergency fund amount. This should include rent or mortgage payments, utilities, groceries, insurance premiums, and any outstanding loan EMIs. Once an investor has this total, they must multiply it by the number of months they want to be covered. Investors should aim for a fund size that aligns with their risk tolerance and financial goals.

Where should investors park their emergency funds?

Investors generally consider liquid mutual funds as an ideal option for growing their emergency funds. Liquid funds offer several advantages for investors.

  • Liquid funds yield higher returns compared to traditional savings accounts. On average, they provide an annual interest rate ranging from 6% to 8%. 
  • Moreover, liquid funds are renowned for their liquidity. Unlike other investment avenues that may tie up your money for years, liquid funds offer high liquidity. Investors can redeem their liquid fund units within 2 to 3 business days from a liquid fund.
  • Additionally, liquid funds are relatively low risk compared to equity investments or other mutual funds. They predominantly invest in short-term debt instruments and money market securities, making them a stable choice for parking your emergency fund. 

Financial uncertainties can arise at any moment, and investors must have an emergency fund to deal with these uncertainties. To determine the right size for your emergency fund, you must calculate your essential monthly expenses and aim to save enough to cover three to six months of those costs. 

Establishing and growing an emergency fund is a crucial step toward achieving financial stability and peace of mind. Investors can build a robust financial safety net that can withstand life’s unexpected twists and turns by following the roadmap outlined in this article.