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The Panacea in Distress

Not all risks in life can be insured. You can insure your life and also your valuables, but certain events fall outside the boundaries of insurance. Any loss suffered must be the result of an unforeseen and sudden happening to qualify as an insurable risk. Insurance policies are bound with restrictions and conditions, leaving several emergency events outside their purview. Any emergency is marked by two important incidents - one, it is an event that is not predictable and, secondly, once it occurs, it will need immediate action. A temporary disability or a job loss could be among those undesirable events. Liquid cash is what one needs at this stage. Liquidating long-term savings may not be the best of options at such time as each such investment is linked to a specific goal. However, certain types of mutual funds can help you during such times.

EMERGENCY FUNDING

An emergency fund has to be liquid. The most ideal are the schemes from the liquid funds category of mutual funds (MFs) which invest in debt instruments, such as, treasury bills, commercial papers and the call money market which have short-maturities. This keeps the returns stable and less volatile. Their objective is to preserve principal while yielding a moderate return and offering high liquidity. The basis for choosing liquid funds for emergency funding is two-fold. Their zero exposure to volatile assets such as equities keeps the returns stable while these are instruments in which you can get your funds back in less than three days, something that matters most during cash emergencies.

If it is income risk such as job loss that is also being factored in, all the money need not be very liquid. You may alternatively look at short-term debt funds to tide over the fund crunch.

In the higher income category, having a reasonable amount of money in short-term debt funds makes sense since capital gains or dividends will be more tax-efficient than interest income. Equity funds or stocks are not the right place to park emergency money. Dull market conditions or low value of your MF schemes or stock will hamper your objective. For good returns though, you will have to invest in higher risk and long-term investments such as equity.

HOW MUCH

There’s no fixed rule as to how much of emergency cash you should keep. As a thumb rule, three to six month’s household expenses can be kept as emergency fund depending on your age.

Roughly the amount that gives you the confidence to combat emergencies in your household should be enough. Anything more can actually affect your investment portfolio.

Those in their 20s and 30s might need more and should aim to garner funds for about six months’ expenses. In the younger days, one should cover for things such as instalments for loans and medical expenses for aged parents. The amount of emergency fund will actually increase in old age as the probability of emergencies will increases. How much you finally save as emergency fund will ultimately depend on what makes you feel comfortable. If you are the risk-averse type, then you would prefer a large fund of, say, a year’s salary and if you are the livingonthe- edge type, then six months emergency fund will do.

APPROACH

There’s no need to starve yourself to build up an emergency fund. Regular contribution is the key. For instance, if you save 10 per cent of a monthly salary of `25,000 in this fund, then in five years, you will accumulate more than `1.5 lakh. Of course, this fund will be in addition to other safeguards, such as insurance policies, which will come to good aid during a prolonged crisis.

Next To Come: Saving for Married Life