Are liquid funds ideal for building an emergency fund?

The coronavirus pandemic has made people realize the importance of having an emergency fund. Several people have lost their well paid jobs and the conditions are worst for daily wage laborers. However, such unforeseen problem could have been averted on individual level if people had allotted a portion of their savings to building an emergency fund. To tackle life’s unforeseen exigencies. To build an emergency fund, there are few things that investors must take into consideration.

To begin with, investors must first make a list of all their monthly expenses and ensure that they keep their expenditures to minimum.  The whole purpose of having an emergency fund is to ensure that if any such pandemic or financial crisis arise in future, one must have enough funds to sustain for minimum three to six months. Financial needs of every individual may differ depending on the lifestyle one has adapted themselves to. Investors must calculate the minimum amount that they need to take care of their monthly expenses. These can include all utility bills, monthly EMIs (if any), house rent etc. An emergency fund must exclude unnecessary expenses like frequent dinners at fancy restaurants, fuel expenses, weekly visits to multiplexes and movie theaters and any such unwanted expenses.

What is a liquid fund?

A liquid fund is an open ended debt scheme which predominantly invest in debt securities that have a maturity period of up to 91 days. A liquid funds invests majority of its investible corpus in treasury bills, commercial paper, government securities, etc. Since these funds invest in securities with such low maturity rate, a liquid fund’s investment portfolio is void of interest rate risk and credit risk. The investment objective of almost all liquid funds is to ensure that the investor’s corpus remains unaffected by any fluctuations in the interest rates. This is why, liquid funds aren’t known to generate wealth. However, they do offer financial stability and ensure that your money earns interest without facing much volatility.

What makes liquid funds ideal for building an emergency fund?

The whole purpose of having an emergency fund is to ensure that you have money in your hand to smoothly roll over like unforeseen exigencies. As its name suggests, liquid funds offer immense liquidity to its investors. In case of an emergency, investors can sell their liquid fund units and money is usually transferred to their registered savings account within 24 hours. Also, another big advantage of investing in liquid funds is that investors need not redeem their entire corpus. Only the amount that is needed can be withdrawn while the remaining corpus can continue to accrue interest.

Investing in liquid funds is better than investing in bank fixed deposits, especially if you are building an emergency fund. Although both liquid funds and bank FDs offer almost similar returns, your money is locked in for a minimum of three years. This makes liquid funds a clear winner as investors can invest or redeem their fund units on business days.

If you wish to ensure that you continue investing in liquid fund to build a commendable emergency fund, consider starting a monthly SIP. Systematic Investment Plan is an investment tool that allows retail investors to invest fixed amounts at regular intervals. All an investor has to do is complete all the pre-investment formalities and become KYC compliant and they can start investing in liquid funds from the comfort of their home or office using a smartphone or a laptop and navigating through the fund houses’ website.

Although liquid funds are safer than equity schemes, they do not offer guaranteed capital appreciation. However, they are ideal to give your mutual fund portfolio the liquidity it deserves.