Determining the right size
The size of an emergency fund depends on personal circumstances. Aakanksha Shukla, AVP – Wealth Management at Master Capital Services, explained, “While 3–6 months of expenses suits most, self-employed individuals or those with irregular income may need 9–12 months. Base your fund on income stability, family needs, and healthcare coverage.”
Trivesh D, COO of Tradejini, added, “Calculate your essential monthly expenses and multiply that by at least six months for a good safety cushion. Age, family size, health issues, and dependents also matter.”
What should an emergency fund cover?
Financial advisors recommend that an emergency corpus primarily cover essential expenses and debt obligations, including rent, groceries, utilities, medical costs, and EMIs.
Shukla added that while discretionary spending can be excluded, a small buffer for occasional needs can reduce stress during a crisis.
Trivesh noted, “Discretionary spending can usually be reduced, cut, or postponed in a crisis.”
Where to park the fund?
Safety and liquidity are key considerations when investing an emergency fund.
Savings accounts and fixed deposits (FDs) provide easy access but offer low post-tax returns of around 2–3% and may include penalties for early withdrawal.
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Liquid and ultra-short duration mutual funds are also recommended.
Shukla explained, “Liquid funds provide better gross yields of 5–7% with T+1 redemption, while ultra-short duration funds can deliver slightly higher returns of 6–7%, though they carry minor interest rate risk.”
Trivesh added, “Investing in liquid mutual funds helps the money grow while keeping it accessible. Ultra-short-term debt funds are another choice, ensuring your money remains useful and hassle-free.”
Arbitrage funds can also be considered for partial allocation, offering tax benefits such as a ₹1.25 lakh exemption after one year, though debt taxation can limit post-tax returns to 4–5%.
Experts caution against risky assets like equities or long-term bonds, which can jeopardise liquidity during emergencies.
Common mistakes
Both Shukla and Trivesh highlighted common errors when managing emergency funds. These include underestimating the required corpus, investing in volatile assets, locking funds in long-term FDs or real estate, and mixing emergency savings with long-term investment goals.
Regularly reviewing and adjusting the corpus as expenses grow is essential to maintain its effectiveness.
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