Emergency Fund – Recurring Deposits and Debt Mutual Funds
Emergency fund always come to fore whenever economic slowdown, market volatility and liquidity crunch occurs. Bank recurring deposits and debt mutual funds are the best options for building up an emergency fund.
What is an emergency fund?
An emergency fund is the savings set aside to cover unexpected financial requirements or emergencies. This is required for meeting essential and emergency requirement like medical expenses. Normally, investors are advised to maintain approximately 4-5 times of monthly income in high liquidity saving instruments.
What is the best way to create an emergency fund?
The best way to create an emergency fund is opening recurring deposits in banks. The best form of emergency fund is term deposits with banks because of the high liquidity, good return and easiness to convert into money. In recurring deposits, you can deposit a predetermined monthly amount for a period specified at the time of opening of account. On due date, the principal plus interest will be returned to you which can be converted to fixed or term deposit with banks.
Can debt mutual funds be used for emergency fund creation?
Debt mutual fund is another option available to an investor to create the emergency fund. Normally, return from liquid funds is similar to or slightly higher than bank fixed deposits. The mutual fund investment is slightly risky compared to bank deposits and hence the higher return. Debt mutual fund is suitable for investors with low to medium risk appetite and for investors nearing retirement. Partial investments in debt funds, enables to balance the risk and improve returns. As in the case of recurring deposits, the amount can be built over a period through systematic investment plans (SIPs). SIP route enables to tide over market volatility and average out the cost of investments.
What are the risks faced by debt mutual fund schemes?
Net asset values (NAVs) of debt funds are less volatile compared to equity funds, yet they too are subject to market risk and credit risk. The NAVs of debt funds are influenced by interest rate cycles and credit risk. Fluctuations in interest rate in market affect the value of investment and lead to market risk. Credit risk arises, if the issuer of the instrument fails to repay the interest or principal on due dates. Because of the risks associated with the debt funds, it is important to choose debt funds with lower credit risk, better portfolio diversification, short-to-medium maturity profiles and inherent high liquidity.
What are the different types of debt mutual fund schemes?
There are different types of debt mutual fund schemes. Debt funds are categorised based on the tenure or nature of debt instruments in which the funds are investing. Liquid funds, overnight funds, money market funds, corporate debt fund and dynamic debt funds are major among them.
Can you suggest three debt funds for emergency fund creation?
Three debt funds suitable for emergency fund creation are:
They are suitable for short to medium horizon. The investments can be made through SIP too. First two funds are suitable for investors with low to medium risk appetite while the third category is suitable for medium to high risk appetite investors.
Investors please note that mutual fund investments carry various kinds of risks and shall seek advice of their financial planner before investment.
