Building your Emergency Fund with Liquid Funds

Personal finance
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Financial preparedness is a crucial parameter to consider while investing. An emergency fund can help you tide over unforeseen costs and ward off debts.

These unforeseen costs could be in the form of:

  1. Medical expenses
  2. A job loss
  3. Repair work to your home or car
  4. Unexpected travel expenses

In short, an emergency fund portfolio should meet this checklist:

  • Is it liquid : Liquidity refers to how quickly your investments can be converted to cash. Invest in instruments that do not attract high penalties or exit loads.

  • Does it prioritize safety over returns: It needs to be relatively less risky during market ups and downs. Avoid saving in instruments that have a high risk for capital erosion, instead, prioritize safety over returns.

  • Low correlation with other asset classes: Your investment portfolio has several asset classes, itā€™s important to evaluate how your emergency fund fits in with the rest of your portfolio.

  • Does it match your risk appetite : If you are conservative and have a low threshold for risk, you might want to consider a higher sum dedicated to your emergency fund.

  • Is it separate: It should be separate from the funds dedicated to long-term or short-term goals. This keeps you from tapping into mutual funds reserved for long-term goals.

Where to invest

Consider financial instruments that follow the SLR (safety, liquidity, and return) philosophy while building this corpus. In short, you need to prioritize the safety and liquidity of your money over returns.

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Consider switching to Liquid Mutual funds for building your emergency corpus.

What is a Liquid Fund

A Liquid Mutual Fund is a debt fund that predominantly invests in liquid money market and debt securities which are of short duration maturity of upto 91 days. The invested money is parked in market instruments such as Certificate of Deposits (CD), Commercial Papers (CP), Government securities (G-secs), Treasury Bills (T-Bills), and so on.

Liquid Funds are named so because it offers high liquidity of the capital for its investors. Some liquid funds can be redeemed within 1 business day. It is not overly sensitive to the interest rate changes due to its short duration and is relatively less volatile than other types of mutual funds.

How do you start

You can have an emergency fund as the base of your investment portfolio. It is the first step that you need before you plan to invest in other avenues that help you achieve your goals.

How much to set aside

The size of your emergency corpus must be in tandem with your lifestyle and risk tolerance.

If you are a very conservative person, you might want to keep a higher sum to deal with any financial emergency. if you are young and have no significant financial obligations and dependents yet, you may set aside only six months of expenses for emergencies.

As a general guideline, you need to have enough money to keep up with your consumption pattern for at least six to 24 months. For example, if your monthly expenses are Rs 100,000 then your emergency fund could be 100,000x12 = Rs.12,00,000.

If you are beginning to save, you can start with one month and then gradually build it up from there.

In short, an Emergency fund acts like your backup plan and works like a reset button to get your financial health back on track.

Disclaimer: The views expressed here in this Article / Video are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The Article / Video has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of the Article / Video should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments. None of the Quantum Advisors, Quantum AMC, Quantum Trustee or Quantum Mutual Fund, their Affiliates or Representative shall be liable for any direct, indirect, special, incidental, consequential, punitive or exemplary losses or damages including lost profits arising in any way on account of any action taken basis the data / information / views provided in the Article / video.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

2 Likes
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Could you please advise me if possible the following:-

  1. Is liquid fund 100% capital protected.
  2. How long will it take to sell/redeem part of the fund.
  3. To buy the fund is it free - absolutely free.
  4. Can we redeem on a weekends and on public holidays

The reasons for asking is the following.

The very meaning of emergency fund is to ensure that you have the capital ready and available when you need it the most. Returns is important but not off paramount importance.

When these are the two essential criteria of a emergency fund, the only product that we have in India which matches this is Bank Savings Account and Bank FD.

There are banks who offer returns in the range of 4.5 to 6%. The counter argument is taxation. For an amount upto 40,000 as interest no TDS is charged. This means that approx upto 8 lacks if you invest in FD there will not be any TDS. You can even park money in another bank or put the money in your family members name. Remember there is always form 15H which can signed so that Bank will not deduct TDS.
The other counter argument is money is available and can be used elsewhere. I am sure you will agree that these planning are for people who are disciplined. If not there is no need for these funds.

The critical issue that a person who is building up this fund is to ensure how much amount he can withdrawn from an ATM in case of an emergency per day and can the ATM be used on a POS terminal. Emergencies in night and paying hospital bills.

If the person is really savvy and wants higher return, he can even think of FD if the rates are higher and then seek an OD against that. Interest is charged only when funds is withdrawn.

All of the above I can do without paying a penny. I can withdraw the funds any time 24/7. Funds can be moved through IMPS, NEFT and RTGS 24/7. This is what emergency funds are for.

I just do not understand the rationale of placing this emergency fund which I cannot withdraw on a public holiday, and week ends. How does the emergency get met on these days. I am sure you will agree that medical emergency or any other emergency needs will not wait for a weekday.

Do not look at emergency as only job loss where you have time to withdraw money. Real emergency are medical and accidents. To call an ambulance you need to pay cash my friend at that time, this liquid fund earning returns will not be a solace but an ATM card will.

These are my personal opinion (I do acknowledge your disclaimer on the subject) and will never invest my emergency funds in liquid fund. It is just not right for me.

6 Likes
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Liquid Fundsā€™ AUM is decreasing across the segment.

Also read this article which compares FD and Liquid Funds.

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I agree. Parking money in liquid funds used to make sense a couple of years ago, when the YTMs were in the 8%-9% range and were on par with FD returns. Nowadays, liquid fund YTMs are not even on par with SB interest rates from some of the new banks.

It makes no sense for me to put money in liquid funds. Using liquid funds as emergency backup is also fraught, for the reasons that @neha1101 listed.

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Hi @ neha1101, @rupeshmandal, and @ ZeroIndian thank you for your response to our post. We acknowledge your concern and agree that Liquid Funds do not have 100% capital guarantee like a fixed deposit. However, as liquid funds invest in money market and debt securities which are of short duration maturity of upto 91 days, it is not overly sensitive to interest rate changes as mentioned in the article.

Also, you can redeem from Liquid funds using the Instant Redemption Facility and receive the amount within 30 minutes from the time of redemption. Instant redemption facility makes your investments in liquid funds accessible during weekends and holidays too. You can redeem up to Rs 50,000 or 90 per cent of the portfolio value in liquid funds (whichever is lower) using this facility with the IMPS feature from your bank.

You can buy liquid fund online by choosing direct plan from the respective mutual fund houseā€™ website without paying any commission/ Transaction Charges. Only charges applicable will be the expense ratio for management of the fund.

RBIā€™s measures to increase liquidity during the pandemic have led to the fall in liquid fund yields and returns. However, it is an alternative to consider apart from fixed deposits to build your emergency corpus due to the ease of redemption and relatively low volatility compared to other types of mutual funds.

Hope this clarifies your concern. You may visit our website to know more about Liquid Funds and the instant redemption facility.

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Thanks @Quantum_AMC for your reply. My gripe with using liquid funds is not about safety or liquidity, but about returns. A couple of years ago the expected returns (as shown by the Yield-To-Maturity, YTM) was around 8%-9%, and then it made sense to park money in liquid funds. This is not the case now. Consider:

  • The safest savings bank account (SBI) gives interest at 2.7%.
  • The YTM of Quantum Liquid Fund is currently 3.27%. (Sorry, I could not find this number on your companyā€™s website in a form which can easily be linked. I am sure it is there in one of the scheme PDFs.)
  • Your original post talks about someone whose monthly expenses are Rs.1L. For such a person it is safe to assume that they fall in the 30% tax slab. The effective tax rate for redemptions from a liquid fund before the completion of 3 years from the date of deposit for such a person is 31.2%, so the expected post-tax returns from Quantum Liquid Fund, for an emergency redemption (or any redemption before 3 years are over) is 3.27*0.688 = 2.25%. Compare this with the pre-tax return of 2.7% from an SBI SB account.
  • SB interest is also taxable at slab rate, but the first Rs.10K of SB interest is exempt. This means that the interest from the first Rs.3,70,000/- kept in an SB account throughout the year is fully tax-free. If someone keeps the entire Rs.12L from your example in their SBI SB account, the effective post-tax interest is 2.12%. The difference between this and the post-tax return from keeping the same amount in Quantum Liquid Fund (assuming emergency withdrawal) is 0.13% in favour of Quantum Liquid Fund.
  • This was all about the safest possible SB interest rate. There are popular banks which give 5.5% and 6% interest, and if the Rs.12L is kept there then the picture, I imagine, would change a lot in favour of the SB account (I havenā€™t done this computation).

So, this is my objection to putting money into liquid funds at the current juncture. Of course, if the rates improve, then the objection goes away. But as of today, in my eyes, liquid funds are really not a good option, especially for money that could be required before the 3 years are up and LTCG rates (with indexation) kicks in.

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Absolutely Correct Observation. Better to keep the money in some savings account. Even Kotakā€™s 811 scheme on Savings Acc. is giving 4% returns on above Rs. 1lakh and below 1cr. While some new banks and NBFCs giving 6 to 7% as well. One can keep a maximum of Rs.5 lakh in each.

1 Like
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Never knew this. Thank you for patiently explaining this. Is this feature only with your AMC or for all liquid funds.

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This feature is there with some other liquid funds as well. Not all.

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@neha1101 You wonā€™t be able to utilize the ā€˜instant redeemā€™ feature of select Liquid Funds on Zerodha Coin. The reason being Coin offers Mutual Funds in Demat format. You wonā€™t be able to withdraw after market closes and during the weekends or on holidays. Itā€™s a limitation of Demat account.

In case you wish to keep money in Liquid Fund with ā€˜insta redeemā€™ in mind, better invest directly on the AMC website which keeps mutual funds in SOA (Statement of Accounts) format.

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Even though liquid funds have less market changes with respect to interest rates, thereā€™s no guarantee about the returns they fetch.

Liquid funds have both pros and cons that Iā€™ve noticed after investing in them with my finvasia account.

Pros includeā€¦

short duration maturity
less sensitive to interest rate fluctuations
revolves around the liquid funds

And cons includeā€¦

do not have guarantee on capitals
returns not guaranteed
changing tax structures

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I want to build an emergency fund and everyone suggested that start saving in a liquid fund but when am seeing the 5-year CAGR of some of the liquid funds is only 4.3% max, I think it is better to keep it in my bank account.

kindly advice if my understanding was wrong.

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Build your corpus for emergency fund through a Recurring deposit and once the Corpus is made move it to FD. Listed Small finance bank is offering interest rate upto 7.75%. You could open the RD in your parents name, if they are senior citizen, they get additional 0.50%. Check out the interest rate of these banks and upto 5 lacks the listed small finance bank are insured.

Disc: Not an expert, please do your own research especially with regard to tax.

1 Like