Where Should You Build an Emergency Fund?

emergency fund

Imagine you lived in Ukraine in early 2022 when the Russia-Ukraine war was at its peak, or imagine living in any part of the world during the lockdowns. You might have felt the need for emergency funds to meet your daily expenses without business income or salary. So let’s discuss the avenues where you should park your emergency funds!

Cash:

Although keeping your emergency funds in cash will earn you no return and will destroy your purchasing power in an inflationary environment, its most beneficial aspect is the liquidity it will provide in times of crisis. You will not have to wait to redeem your money. Hence, a small portion of your emergency funds can be kept as cash. It is important to note that during difficult times, having easy access to your own money will be the priority over earning returns on that cash! Hence, cash as an avenue for emergency funds is not a bad idea!

Liquid mutual funds:

Liquid mutual fund categories such as ultra-short duration and short duration funds exist, which can be used to park emergency funds. A benefit of deploying funds in liquid mutual fund schemes is that they can provide returns at par with inflation and are also liquid. However, it is essential to consider the expense ratios and exit loads (if they exist) before investing in any particular scheme.

Recurring deposits:

A recurring deposit is a good place to deploy your emergency funds. These are short-term deposits where you have to deposit a fixed amount every month and get a specified amount at the end of the tenure. An advantage of recurring deposit is that it helps you build a savings habit and an emergency corpus over time!

Savings Account:

Emergency funds can also be parked in savings accounts as these are also quite liquid, although less liquid than cash. Also, money kept in a savings account provides modest returns, typically lower than inflation when calculated on an after-tax basis. However, parking emergency funds in a savings account can also become risky when the banking system is unstable or when frequent bank runs are experienced in a country/region.

Money Market instruments:

Money market instruments include short-term interest-bearing instruments such as certificates of deposits, treasury bills, and commercial papers. These are ultra-short-term liquid instruments and can be liquidated with ease. Hence, money market instruments can be used for parking emergency funds.

This is the essence of emergency funds. It protects you from a rainy day’s worth of expenses. It is also important to note that investors can spread their emergency fund corpus across multiple avenues to diversify the risk of illiquidity in case it arises.

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