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    How to plan for emergencies

    Synopsis

    Ideally, an emergency fund should be equal to six months of their monthly expenses, including EMIs on outstanding loans and insurance premium obligations.

    Jigar and Bijal Parikh are a young couple having investments in the PPF, shares and endowment policies. Whenever they have surplus funds, they either add to their equity portfolio or spend it. For unexpected situations, such as loss of job, they feel credit card loans and stocks can help. Are they planning for their emergencies in the right manner?

    The Parikhs are absolutely right about creating an emergency fund. However, they should reconsider their choice of investments. Their credit card can give them instant money, but it comes at a very high cost. Their equity stock portfolio may be highly liquid, but its value may drop significantly just when the funds are needed.

    An emergency fund should be held where the focus is on liquidity, safety of funds and reasonable cost. Ideally, an emergency fund should be equal to six months of their monthly expenses, including EMIs on outstanding loans and insurance premium obligations.

    Investment options that typically meet the requirements of liquidity, safety of funds and reasonable cost are bank deposits. Other options that are suitable for an emergency are liquid funds and short-term debt funds, which offer reasonable returns, low cost and low volatility.

    These funds deploy money in short-term instruments and pass on the returns to investors at a cost. They can be withdrawn whenever needed and most funds pay the amount in one working day. There is no guarantee on these funds, but they are managed in a way that the chance of losing value is very low.

    Stocks, bonds and even deposits are medium to long-term investments and may not be available in times of an emergency. Credit cards or any other loans tend to increase costs in difficult times.

    The Parikhs need to have an emergency fund of 3-6 months of living expenses. It will mean a considerable sum of money lying idle and earning low returns. However boring it may seem, this money is doing exactly what it is supposed to, waiting to be used in case of an emergency.

    The content is courtesy Centre for Investment Education and Learning (CIEL). Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta.

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    (Your legal guide on estate planning, inheritance, will and more.)

    Download The Economic Times News App to get Daily Market Updates & Live Business News.

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