You could be an individual who has just begun an ambitious career or a mid-aged employee who is working hard to fulfil the financial needs of your dependents or a person who is a few years away from retirement. Irrespective of where you belong, an unexpected financial crunch may bring you to a grinding halt.
Such a financial crunch may occur due to a job loss, an accident or a medical emergency which renders you incapacitated to earn. You cannot predict such events with certainty.
However, you may provide for them with the help of an emergency fund. Building an emergency fund needs to start the moment you embark on financial planning. Moreover, it is an important step that should precede all kinds of long-term investing.
What is an emergency fund?
It might happen that you have set aside funds for some goal and you are forced to use it for an emergency need. Alternatively, in another instance, you may have to borrow at a high-interest rate to meet a contingency.
If you face these situations often, it means that there are loopholes in your financial plan. It also implies that you badly need an emergency fund which will help you wade through these contingencies.
An emergency fund acts as a buffer whenever there’s a temporary financial crunch. It helps you to come back to the normal situation without needing to divert funds into unproductive purposes.
Now, if you feel that the few rupees lying in your savings bank account is an emergency fund, then think again. An emergency fund is a full-fledged contingency plan which provides a safety net against sudden cash requirements.
It is a sum that is good enough to meet your three to six months of living expenses. Imagine a situation wherein you lose your job and are required to sit at home.
In such a scenario, an emergency fund should have sufficient funds to support you till you find another job. The quantum of funds to be set aside may vary as per your requirements.
If you are leading a high-end lifestyle or have dependents to take care of, then you may have to park a higher sum in the fund.
Similarly, if you own a business which is facing losses right now, then you may need to put at least six months of savings in the fund. Before arriving at an absolute figure, take stock of your cash flows, expenses, obligations.
How to create a fool-proof investment portfolio?
Once you have taken account of your cash flows, you may begin creating a portfolio that is cash crunch proof. Here, you need a haven which fulfils three considerations in an optimum way, i.e. liquidity, decent returns and low/nil exit load.
You need to park your emergency funds in a haven which provides withdrawal round the clock. Moreover, upon withdrawal, you should not lose money by way of penalty or exit loads. Apart from that, you can also expect a higher rate of return than a savings bank account.
From this standpoint, liquid funds seem ideal investment avenue. A liquid fund is a mutual fund scheme which invests in fixed-interest generating securities like treasury bills, certificate of deposit, etc.
It does neither have a lock-in period nor any exit loads. You may easily withdraw funds in the event of an emergency. Additionally, it offers returns in the range of 7%-9% which is higher than a bank account.
The fund manager invests only in those securities which have a maturity of up to 90 days; this keeps extreme fluctuations in the fund value at bay. Moreover, only high-credit rated securities are chosen to reduce the risk of default.
Try allocating some portion of your investment portfolio in liquid funds and stay steady during emergencies.