Life is full of uncertainties. From job loss to unexpected medical bills, financial emergencies can strike at any time.
That’s why building an emergency fund is a crucial step towards financial security. But where should you invest this fund to ensure easy access and potential growth? An emergency fund is a pool of money set aside to cover unexpected expenses. The goal is to have enough saved to cover three to six months’ worth of living costs. While it’s important to have this safety net, it’s equally important to invest it wisely. In this guide, we’ll explore the best investment options for your emergency fund.
What’s an emergency fund?
An emergency fund is money you keep aside for unexpected expenses. It’s there to help you out when you need it most, like if you suddenly lose your job or have to deal with medical bills that your insurance won’t cover.
For example, let’s say you unexpectedly lose your job. Even if you have some savings in the bank, it might not be enough to cover all your expenses until you find a new job. An emergency fund gives you a safety net to fall back on during times like these.
Despite its importance, many individuals and families overlook building an emergency fund. However, it should be a priority before considering other financial goals. It acts as a foundation for financial stability, providing a safety net to weather unexpected financial challenges.
How much money should you maintain in your emergency fund?
The ideal emergency fund size isn’t one-size-fits-all. While 3-6 months of expenses is a good starting point, consider your unique situation. Factor in your essential monthly costs, job security, and lifestyle to determine the right balance for your emergency corpus.
Where to invest emergency corpus
Fixed Deposit
Fixed Deposits usually offer higher interest rates compared to savings accounts, but they often require investors to lock in their money for a specific period. However, in some cases, you can withdraw from a fixed deposit early by paying a small penalty. Some banks even allow penalty-free withdrawals from fixed deposits. The interest rates on fixed deposits typically range from 3% to 7% annually. Keep in mind that the interest earned on fixed deposits is fully taxable at the individual’s applicable income tax rate. Also, senior citizens may qualify for a deduction of up to Rs. 50,000 per annum under section 80TTB if they have a fixed deposit.
Cash
Storing emergency funds in cash might not earn you any extra money and could lose value over time due to inflation. However, having cash on hand is really helpful during emergencies because you can access it right away when you need it most. So, it’s okay to keep a small part of your emergency money as cash. Just remember, when times get tough, having quick access to your own money is more important than making profits on that cash. That’s why keeping some cash for emergencies is actually a good idea!
Liquid Funds
Liquid funds serve as an excellent option for establishing an emergency fund. These funds primarily invest in short-term bonds with maturities of up to 91 days. Known for their low-risk nature, liquid funds provide investors with the potential to earn higher returns compared to traditional savings accounts. Additionally, being classified as debt funds, liquid funds offer favorable taxation. Upon selling a debt fund after a three-year holding period, any gains are considered long-term capital gains, subject to a 20 percent tax rate post-indexation. Indexation adjusts the purchase price based on inflation, thereby reducing tax liabilities.
High-Yield Savings Account
Setting up a high-yield savings account as an emergency fund is a smart move. These accounts are mostly offered by online banks, so you won’t find them at traditional brick-and-mortar banks. Just keep in mind, you can’t pop into a physical bank branch to withdraw money from these accounts. You’ll need to transfer funds to and from another bank account, which might take some time during emergencies.
Still, high-yield savings accounts are quite accessible and offer better interest rates compared to regular savings accounts. Many of the top accounts earn over 2.00% annual percentage yield (APY), depending on factors like your account balance.
Lots of online banks have high-yield savings accounts available. When you’re choosing one, make sure to check out the interest rates, any fees involved, extra benefits, cash deposit limit in a savings account, and other rules about withdrawing money.
Money Market Instruments
Money market instruments are like short-term savings options such as certificates of deposits, treasury bills, and commercial papers. They’re easy to cash in quickly, making them ideal for emergency funds.
Having an emergency fund gives you a safety net for unexpected situations. Consider options like high-yield savings accounts or liquid funds, which allow you to access your money quickly. These tools can help you manage through tough times without financial stress. Start building your emergency fund today and work towards a more secure financial future.
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