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 an emergency fund is a financial safety necessary to address challenges arising from medical emergencies, job loss, urgent repair of your home or car, and other unplanned situations. Secure your financial future by learning how to smartly invest emergency fund.
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.
Why Are Emergency Funds Important?
There are many reasons why emergency funds are important. Here are a few of the most important:
To avoid debt: When you have an invest emergency fund, you don’t have to borrow money to cover unexpected expenses. This can help you avoid high-interest debt, such as credit card debt.
To protect your credit score: When you use credit cards to pay for unexpected expenses, you increase your credit utilization. This is the percentage of your available credit that you are currently using. A high credit utilisation can hurt your credit score.
To reduce stress: When you don’t have an emergency fund, you may be worried about how you will pay for unexpected expenses. This can lead to stress and anxiety. Invest emergency fund can help you feel more secure and less stressed about money.
How to Start an Emergency Fund
There are a few things you can do to build an emergency fund:
Set a goal: The first step is to set a goal for how much money you want to have in your emergency fund. A good goal is to have three to six months of living expenses saved.
Make a budget: Once you know how much money you want to save, you need to make a budget. This will help you track your income and expenses so you can see where you can cut back.
Automate your savings: One of the best ways to invest emergency fund is to automate your savings. This means having a set amount of money automatically transferred from your bank account to your investment each month.
Make extra payments: If you can afford to make extra payments on your debt, you can free up more money to save for your emergency fund.
Cut back on unnecessary expenses: Take a close look at your spending and see where you can cut back. This could mean eating out less, cancelling unused subscriptions, or shopping at thrift stores instead of new stores.
How to Calculate Emergency Fund?
The answer depends on your age and monthly expenses but a good rule of thumb is to have enough to cover six to nine months’ expenses. For example, if you earn ₹50, 000 monthly and ₹35, 000 of that goes into meeting all your expenses, then your emergency fund should be something between ₹2, 10, 000 to ₹3, 15, 000 (₹35, 000 multiplied by six or nine).
One important thing to remember while calculating your monthly expenses is to consider EMIs and insurance premiums that need to be paid.
Monthly expenses (Rent + Food + Clothing + Children School Fees + EMIs + Mis)* 6 Months = Emergency Funds
This can feel like a huge number, especially if you’re starting from scratch, but it is not really that difficult to put together. The important thing is to start putting some money aside every month.
Where to Invest Emergency Fund?
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 to invest emergency fund 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.
Here are the best ways to invest emergency fund:
Savings bank accounts are one of the ideal way to invest emergency fund. 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 to invest emergency fund.
Fixed Deposits/ Recurring Deposit
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 emergencies.
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 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.
Liquid Mutual Funds
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.
T-bills and G-Sec
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.
FAQ: Invest Emergency Fund
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.
Can FD be used as an emergency fund?
FDs can be the star asset of invest emergency fund, diversifying it to reduce risks. For maximum benefits, try combining FDs with other liquid assets like money market funds or savings accounts to create a balanced emergency fund strategy.
What is safer than FD?
The post office time deposit (POTD) is an alternative to bank fixed deposits for those looking for fixed income. It is safer than an FD because the principal invested and interest earned are backed by a sovereign guarantee. In a POTD, there are four tenure options- 1, 2, 3 and 5-year deposits.
Saving and investing for an emergency fund is a crucial aspect of financial planning. It provides a safety net and peace of mind knowing that you have funds set aside for unexpected expenses or income loss.
The amount to save and to invest emergency fund depends on various factors, such as your monthly expenses, income stability, and risk tolerance. It is generally recommended to aim for three to six months’ worth of living expenses.
By diligently saving and considering low-risk investment options like high-yield savings accounts or money market funds, you can grow your emergency fund over time. Remember, emergencies can happen at any time, so it’s important to start saving and investing as early as possible. Read More – SustVest
Founder of Sustvest
Hardik completed his B.Tech from BITS Pilani. Keeping the current global scenario, the growth of renewable energy in mind, and people looking for investment opportunities in mind he founded SustVest ( formerly, Solar Grid X ) in 2018. This venture led him to achieve the ‘Emerging Fintech Talent of the Year in MENA region ‘ in October 2019.