Liquid funds: Your financial shield when emergency strikes
There are two kinds of people in the world – one, who have faced an emergency and others who haven’t. If you are among the former, you would have surely built a contingency fund by now. However, the latter may not have seriously thought about it. The COVID-19 pandemic came as a rude shock to those who lost their jobs or faced pay cuts. A contingency fund in such a scenario comes to the rescue. If for some reason you have not yet given a thought to contingency funding, you need to pull up your socks.
The first check post on your way to financial freedom is having enough corpus, to which you can turn to in emergencies. We at Caterpillar suggest setting aside at least six to nine months of your income that you can fall back on, in case of health, loss of income, or other emergencies. The higher your salary and monthly expenses, the more emergency corpus you will need. So, anyone earning more than Rs 25 lakh has to have a nine-month emergency safety net. The people earning below that may set aside up to four-six months of monthly income.
You cannot rely on your equity investment or PPF or EPF money for emergencies. Emergency funds must be liquid enough that you can access them in a couple of hours. Most importantly, it should be parked somewhere safe that you can be assured of its safety. We suggest our clients keep at least two-three months of emergency funding in cash in bank accounts or fixed deposits. Let’s face it, when an emergency strikes, nothing but cash at home or the nearest ATM will be the most accessible. Redeeming other investments will take time. However, it doesn’t mean that all your emergency funds lay idle in your bank account.
As suggested above, keep at least two-three months of your emergency funding in the savings bank account or fixed deposits. The rest can be parked in safer investment avenues, preferably liquid funds. These funds invest in money market instruments of typically less than 90 days of maturity. Unlike other mutual funds, liquid funds do not have an exit load. So, your money keeps earning some return while you have the liberty to exit any time you want without penalty. The money gets credited to your bank account in a couple of days or in a day’s time depending on the asset management firm you have chosen.
Why invest in liquid funds
— To earn slightly higher returns than FDs on a portion of your emergency funds
— To be disciplined about your contingency money — Human psychology is such that you tend to spend extra cash in your bank account for other purposes. The moment you set it aside in a different fund, your mind will have a natural wall against spending it on anything but an emergency.
Tax on capital gains in liquid funds
The returns on FDs are taxed as per your slab rate. However, if you stay invested in liquid funds for more than three years, the capital gains will be taxed at 20 per cent with indexation. So, people in the 30 per cent slab rate can reduce their tax outgo significantly by investing in liquid funds.
If you hold it for less than three years, the taxation is similar to that of FDs, that is, as per your slab rate.
Setting aside substantial corpus sounds daunting to you? Don’t panic. You may build your contingency fund over a period of time. Taking that first step towards financial freedom is all that you need. Call us on 8178271045 to know more about liquid funds. We will help you compute your emergency corpus requirement.