An emergency fund, also known as a contingency fund, is an essential corpus that you must keep aside to tackle emergencies that arise unexpectedly, such as a job loss, pay cut, or a medical emergency.
Without an adequate emergency fund, you might be forced to redeem your investments earmarked for crucial financial goals or avail loans at high interest rates to deal with the financial exigencies. A financial emergency during bearish market conditions may also force you to redeem market-linked investments at loss.
How should you set your emergency fund?
For starters, the first step is to estimate how much money is required to meet any sort of emergency. It's important to understand that every individual has different financial needs. Hence, the amount will vary for all.
This fund should be big enough to cover unavoidable expenses like daily household expenses, children’s tuition fee, existing EMIs, utility bills, expenses on medicines, insurance premiums, etc. for at least 6 months, said Gaurav Aggarwal — Senior Director, Paisabazaar while talking to CNBC-TV18.com.
Where should you park your emergency fund?
As a financial exigency can strike anytime, one should always park emergency fund in highly liquid financial instruments with high capital protection features, Aggarwal said.
And, what are the options?
High yield savings accounts
As a rising interest rate regime adversely impacts the returns generated by market-linked fixed income instruments and increases the risk of capital erosion, you should park emergency fund in high yield savings accounts offering interest rates of around 6-7 percent per annum in the current economic scenario, as per Aggarwal.
Fixed deposits (FDs)
Those comfortable with internet and mobile banking can park their emergency fund in high-yield bank FDs offering interest rates of 7 percent per annum and above, Aggarwal told CNBC-TV18.com.
Liquid Funds
Investors can park around 30-50 percent of the investible corpus in liquid funds as they offer high liquidity along with better returns than a savings account, according to Harsh Jain, Co-founder and COO, Groww.
Average returns on liquid funds hover around the 6-8 percent mark. With low risks and an opportunity to earn good returns, these funds can help in creating the corpus in a shorter period.
