What would you do when the tire of your car goes flat? You simply replace it with a spare tire and continue your journey. Similarly, having emergency fund investment options is a must as a financial safety to address challenges arising from medical emergencies, job loss, urgent repair of your home or car, and other unplanned situations.
An emergency fund gives you the initial cushion to absorb any financial shock. It gives you the time and stability to plan your next move effectively and make informed decisions.
Importance of Emergency Fund Investment Options in India
An emergency fund is the key to a properly secured financial life and should be prioritized over other investments.
- Helps avoid debt trap: During difficult times, you can rely on such funds to overcome financial challenges rather than on high-interest loans such as credit card loans or from unorganized money lenders.
- Ensures that you do not withdraw from your long-term investments: Withdrawing from your future savings breaks the wealth creation process, and you have to compromise on your future plans. An emergency fund investment option is directly linked to the safety of some critical future goals and aspirations.
- Helps to reduce your stress levels: Having adequate funds in place provides a sense of relief and safety because you know there is a backup plan if something goes wrong.
How Much Should You Have an Emergency Fund?
A general rule of thumb is to have three to six months’ worth of expenses as an emergency fund and up to 12 months in certain cases. So, here’s how it goes. If you have a secured job, lower expenses compared to your income, and are relatively healthy, saving three to four months’ worth of expenses may be sufficient.
But, if you are living in a high-cost-of-living area, a freelancer, or work in a seasonal sector, you need to save more than six months’ worth of expenses as an emergency fund. You must also increase the size of your rainy day fund per your lifestyle, inflation, and job profile change.
How to Save for an Emergency Fund Investment Option?
As mentioned earlier, you should prioritize saving for your rainy days first before saving for other financial goals. Here’s how you should save.
- Calculate your current monthly expenses: You should include your rent, grocery expenses, child’s education expenses, medicinal expenses, bills, and those expenses which are recurring in nature and cannot be avoided. You should exclude all the optional expenses like traveling and restaurant meals.
- Set a saving goal: Now, based on your monthly expenses, work profile, and other risk factors, set a saving goal and calculate the monthly contribution amount you can do. Divide your fund requirement into smaller amounts that will encourage you to keep saving and give you a positive start toward financial flexibility.
- Automate your savings: Automate your savings efforts to eliminate the possibility of missing out on rainy-day savings. Set up automatic deposit accounts, such as a recurring deposit account with your bank, in which a fixed amount is deducted every month at a specific date.
- Assess your emergency fund on a regular basis: Once you hit the savings goal, review your expenses on a regular basis and make adjustments to your corpus.
- Savings Account
- Fixed Deposits
- Liquid Mutual Funds
- T-bills/ G-Sec
The million-dollar question is, where should you save your rainy-day funds, or what emergency fund investment options are available? One of the most important factors to consider before looking into emergency investment options is liquidity.
It means all the emergency fund investment options should be easily accessible, and funds can be withdrawn in a very short time without any difficulty or paying any extra charges. And, the funds should not be invested in riskier asset classes where price volatility is higher. Remember, the goal of emergency savings is to safeguard yourself from financial uncertainties, not generate returns.
Top 5 Emergency Fund Investment Options in India:
Savings bank accounts are ideal for building your emergency fund corpus. Despite offering lower interest rates compared to other investment options, they offer unparalleled access to funds at any time, including holidays.
However, it is crucial to exercise discipline and refrain from withdrawing or utilizing the funds unless a genuine emergency arises. It is recommended to have a separate savings bank account dedicated solely for the purpose of emergency funds.
Fixed deposits are another best investment option to build an emergency fund corpus. Along with the security of funds and liquidity, fixed deposits provide decent long-term growth of funds at a steady rate.
Investing your emergency fund corpus in FDs with different tenures allows you to have flexibility and access to funds when facing emergency situations. By allocating your funds to FDs with different maturity periods, also called laddering, you can ensure that you can withdraw what is needed and allow the remaining funds to continue growing. With Recurring Deposits or RD, you can automate your saving process and build an emergency fund corpus easily.
Gold – Digital Gold, Gold ETFs
Gold is considered a safe haven asset, and its ability to hold value even during turbulent times makes it a unique emergency fund investment option. For this very reason, gold was widely used by households in earlier days when the banking system was in its infancy.
Compared to physical gold, digital gold, Gold ETFs, and Sovereign Gold Bonds (SGBs) are more liquid and superior gold investing options. The government pays an additional 2.5% interest rate annually on the amount invested in SGBs. For example, if you invest ₹10,000 in SGB, the government will pay you ₹250 in annual interest until the SGB matures, which is 8 years from the date of issuance.
Additionally, the value of SGBs is directly tied to the price of gold. As a result, when the price of gold increases, the value of SGBs also rises proportionately.
Among all the categories of mutual funds, liquid funds are best suited for saving as an emergency fund investment option. As the name suggests, liquid funds are low-volatility and highly liquid mutual funds that invest in debt securities with maturities of up to 91 days. The low volatility is due to the fund’s extremely low modified duration.
For example, if the interest rate changes by 1% in a bond fund with a modified duration of 5 years, the bond’s price changes by 5%. Liquid mutual funds have given 50% to 100% higher returns than savings bank accounts.
In comparison to savings accounts, fixed deposits (FDs), and gold, liquid funds usually require one to two days for the funds to be credited to your bank account.
By using a part of your emergency fund corpus, you can consider investing in Treasury Bills (T-bills) and Government Securities (G-Sec). These emergency fund investment options offer guaranteed returns to investors, have high liquidity in the market, and are easily traded on the stock market.
The maturity period of T-bills can be 9, 14, 91, 182, and 364 days. Expect T-bills with 9 days maturity, you can invest a minimum amount of ₹25,000 and in multiples of ₹25,000 thereafter.
While G-Secs have long-term maturities ranging from 1 year up to 40 years. The minimum investment amount is ₹10,000 and in multiples of ₹10,000 thereafter with a maximum limit of ₹2 crores.
An emergency Fund investment option functions similarly to insurance and provides protection against unexpected financial crises.
Building an emergency fund is a step toward financial security and peace of mind. Delaying means you are vulnerable to unexpected events and a step closer to financial hardships. Without a sufficient cushion of savings, even a minor setback can spiral into a major financial crisis.
Always choose investment options for an emergency fund that preserves capital and maximizes safety. It is wise to diversify and avoid putting all funds into a single investment option. Instead, opt for a mix of high-liquidity investments that offer easy access to your funds when needed.
How much money should be in the emergency fund?
An emergency fund with a cash reserve of 3 to 6 months' worth of expenses should be adequate. But, if your job is seasonal in nature, a freelancer or self-employed, you should save more than 6 months' worth of expenses.
What are ideal options to save for emergency funds?
You should save in those emergency fund investment options that are highly liquid, like savings accounts, fixed deposits, liquid mutual funds, Gold, government bonds, etc.
What are the benefits of an emergency fund?
An emergency fund investment option helps you to save for unexpected expenses like medical emergencies, unexpected house repairs, etc., so that your financial stability doesn't get affected.