Contingency Fund — Liquid fund??

POSTED BY Ram Mohan ON March 2, 2012 7:56 pm COMMENTS (33)

All:
I have currently no contingency fund. I only have about 8 lacs in stock market (stocks, mf and debt) of which around 5 or 6 lacs is not locked in. Rest is in tax saving funds.
I’m 32 years old and have decided it’s high time to start a contingency fund.
So my question is:
1) Can I invest monthly say 5K or something in Liquid funds as contingency fund? Is this better than say FD? I can also increase this amount whenever I get some bonus or lumpsum etc. So, please do not calculate that 5K is very little
2) Which option should I go in for? Growth or Dividend reinvestment?
Please note that I already am prepared to sell my existing stocks/mf at whatever loss or gain in case an emergency occurs in the short term (2 to 3 years)
Can members please advise
Thanks,
Ram

33 replies on this article “Contingency Fund — Liquid fund??”

  1. rmohan80@gmail.com says:

    One more question to all experts…

    Is it required to split money parked in 2 liquid funds from different AMCs?

    I’m thinking it is a good idea, not in terms of making more returns, but just to avoid withdrawal problems in case there is some issue at 1 AMC end.

    Please correct me if my view is wrong and also let me know if you think it’s a good idea

    1. Dear Rmohan, please check the following link. Is it fulfilling your liquidity requirements?

      Please confirm.

      http://www.reliancemutual.com/atm-card.aspx

      Thanks

      Ashal

      1. rmohan80@gmail.com says:

        This definitely seems like a great idea. I’m wondering how not many funds have come up with this. For one, HDFC should come up with this as their funds perform better when compared to Reliance.

        I’m not going to go for this, but if HDFC should come up with something like this, it’ll be good

  2. Jig says:

    Thanks Ashal,
    Well In my second question i have cleared that , have to pay money within next six months , not after the six month. I have to pay monthly lumsum. Also i am not aware if any FD is available for such small period ( to NRIs).
    Sorry if i had create a confusion. hope it is clear now.

    1. Dear Jig, Are you sure that NRIs are not eligible to open FDs for the duration required by you?

      Please check the below link –

      http://www.hdfcbank.com/nri_banking/accounts/fixed_deposits/nro_fixed_deposits/nro_fixed_deposits.htm

      Thanks

      Ashal

  3. Jig says:

    Nice discussion goin on here.

    Ques:

    1.What are the chances of eroding the money if put in Liquid Fund or Debt Fund.
    2.Keeping in Saving account or Liquid Fund, which is advisable?( for the ideal money of 5 lac which is required to paid within 6 month for real esate EMI)

    Regards

    1. Dear Jig, although rare but chances of money erosion in liquid funds are there. In case of debt funds, due to change in interest rate cycle, depending up on the fund you are invested in (short or med. or long term fund), there are far higher possibilities of money erosion than liquid funds.

      If you are quite sure of redemption in 5-6 months time & a data is almost fixed, my take ‘ll be to go for bank FDs of your matching duration.

      Thanks

      Ashal

  4. BanyanFA says:

    @ TheZionView – Best Answer.

  5. TheZionView says:

    So much of discussion..good to see

    My 2 cents for EF is

    1 or 2 month expense in Savings Account( a good method if you have any EMI running and salary credit problem occurs)
    Remaining in Liquid Fund.

    Point is when i need the money nothing should be complex in getting it

    1. rmohan80@gmail.com says:

      @ TheZionView — appreciate your answer, but what is complex about getting money from a debt fund? The procedure is same as liquid fund, just the time taken is more. I don’t see a complexity there. I’m assuming you’re not going to need 6 months money overnight. Surely you can make do with 2 months money while you get the rest from the debt fund.

      And my view is that just because it is emergency fund doesn’t mean that we cannot afford to take a very minimal risk with it. Maybe you won’t need it at all, so why not earn a little from it. I’m not talking about greed, but purely letting your money work for you

      1. There are some parts of a Financial Plan that must be agreed to as is!

        Emergency corpus must NOT have a chance to erode slightly over time else it will not meet the definition of emergency corpus. As part of one’s investment planning Asset allocation is EXTREMELY important – http://wp.me/p1Y418-24. If someone exhausts PPF (VPF is still not encouraged by several private companies) then the next best avenue to boost debt portfolio is these Debt funds or tax free bonds that will be in vogue from now on.

        Hence make the money work harder for you by investing in Debt funds as part of your Debt portfolio and keep the emergency corpus in liquid funds.

      2. TheZionView says:

        @Rmohan
        No its completely fine if you to keep it in Debt MF and earn that extra income.My idea for Emergency Fund is simple. When Emergency occurs i might not be reacting in the same way i do now. So i want to keep it simple and keep my worries to overcome the emergency situation and not to worry about Cash at that time. So a 2 month salary in Saving account will keep my mind calm with respect to cash situation in Emergency. Rest i can act slowly in that time period. I agree there is no complexity in a Debt or Bond fund compared to Liquid Fund.

        @BanyanFA Thanks

  6. There has been a lot said already here but what I am adding to the discussion is a spreadsheet comparing investing in FDs/RDs versus Liquid funds. For someone in the 20% or 30% tax bracket sweep FDs/RDs are extremely tax inefficient considering their net returns as evidenced in the spreadsheet.

    Emergency funds need to be Liquid so they can be withdrawn at will. Liquid funds have very short term maturing securities so the interest rate risk is minimal, if any. Breaking Sweep FDs/Regular FDs/RDs will significantly lower returns so this kind of makes them inefficient as avenues for an Emergency corpus (versus liquid funds). And since no one knows when the Emergency corpus will be utilized it is better to take a frequent dividend (say monthly) on Liquid funds to minimize tax out go. Thus liquid funds should become the automatic choice for emergency funds for anyone in the 20% or 30% tax bracket.
    [file]http://localhost/jagoforum2/readers-files/WheretoparkShorttermorEmergencyfunds.xls[/file]

    1. rmohan80@gmail.com says:

      @justgrowmymoney — useful spreadsheet

  7. BanyanFA says:

    Ram,
    If I was you, I would not park my short term emergency funds into Debt funds for the following reasons:
    1. Debt fund prices fluctuate based upon the RBI’s interest rate recommendation and the regular inflation data. Hence you may end up being in losses in the short term if you invest in Debt funds. You must have around 1-2 years horizon for debt fund investments.
    2. Some debt funds attract exit loads;
    3. Debt funds don’t release funds as quickly as liquid funds;
    4. The difference in returns between a debt fund & liquid fund may not be material for you to park your emergency funds into Debt Funds. Currently Liquid funds are offering returns to the tune of 8.5- 9.2%. Conversely debt funds are offering returns between 9 – 9.6%
    5. The overall motive behind an emergency fund is quick release and not to worry about the returns. Hence Liquid funds offer the best solution to this problem.

    Regards
    BFA

    1. rmohan80@gmail.com says:

      Hi BFA,

      The 1 disadvantage I see in Liquid fund is that for many top performing funds, minimum/monthly STP amount is set at 10,000. So If have only say 30,000 that I want to move across from MF, I have to go lumpsum or my total transfer time will be quick rather than spread out across months. This makes debt funds more attractive.

      Again, since this is an emergency fund and you’re not worried about losses. Let’s say your monthly expense is 50,000, then parking 125,000 in liquid fund and 125,000 in debt funds seems ok to me. Even if there is a loss in debt fund (say 1 or 2% — not sure how high or low this number is), then that’s just a loss of around 1250.

      Also, the assumption is that there is term insurance and health insurance to take care of immediate needs and the 3 or 4 days required to release debt funds shouldn’t matter much since you get the liquid funds in 1 or 2 days max

      I think this strengthens the argument of having 50-50 in debt and liquid for emergency funds

  8. Dear Rmohan, first of all please don’t say sorry to ask more & more questions. After all this forum is meant for the same thing only. Questioning & more questioning.

    In case of STP suggested to you, you are redeeming money from Eq. funds & yes purchasing in debt funds. So no tax on Eq. MFs redemption & no tax till the time your money is not redeemed from debt funds.

    Yes redemption from debt funds other than liquid funds may take some time. In that case, you may keep money exclusively into liquid funds & set of cut off limit & above that limit, start transferring money into debt funds as you do not require all of your money in case of emergency within a day in most cases.

    Thanks

    Ashal

    1. rmohan80@gmail.com says:

      Thanks Ashal, I’ll STP money from one fund to liquid and the other to Debt. That will help me keep the balance

  9. Dear Rmohan, as you are redeeming a part of your MFs, my take ‘ll be to use STP of 5K each for each of the 2 funds mentioned by you & divert that amount in to Debt funds of the same AMCs, No need to invest it in to a bank RD. that ‘ll be better from operational as well as taxation point of view.

    Thanks

    Ashal

    1. rmohan80@gmail.com says:

      Ashal,

      I’m a little confused. Can debt fund holdings be considered as emergency fund? Wouldn’t moving it over to a liquid fund be better in that case as the redemption timeline is only 1 day?

      Secondly, I was under the impression that STP means you’re selling and buying…so profits made from the sale is taxable. Looks like I’m wrong.

      Can you clear the above points for me please?

      Thanks,

      Ram

      PS: For other forum members, Sorry to keep a long conversation going here. I hope these doubts will be something others too have and hope this thread will be useful to others as well and not just my personal finance 🙂

  10. Dear Rmohan, even a simple product like bank RD may create a good fund over the period, from those 5K mly amount.

    Thanks

    Ashal

    1. rmohan80@gmail.com says:

      Dear Ashal,

      After sleeping over the problem, I believe I’ve come up with a nice solution. I have 2 tax savings fund (Principal tax saver and HDFC Tax Saver) where I can do a SWP of 5K each per month. Most units are redeemable, but I want to use SWP to maximize gains if possible. In addition to that I’ll put in 5K from my salary.

      So, I’ll put the total of 15K p.m in a RD…That should help me build up emergency fund in the next 2 years without redeeming any of the existing funds..

      Correct me if my approach is wrong. These tax saving funds were bought only to save tax without any goal.

  11. Dear Rmohan, A sensible thing ‘ll be to first make a stock of your current situation & redeem only those MFs or stocks which are not making any marked improvement.

    Thanks

    Ashal

    1. rmohan80@gmail.com says:

      Hi Ashal,

      Agreed; just because I want an emergency fund selling my funds makes no sense. Maybe it’s better I build this fund over a few years…i’ve been without this fund for so many years (married 4 years now and kid 1 year old) so probably doesn’t make sense rushing into selling equity just to have this emergency fund

  12. Dear Rmohan, in this case, I can offer an interesting thought. Please open a separate account meant for contingency funds. Do not activate ATM card against this account or cheque book. Use only netbanking. As there is no cheque book or ATM card, the easy redemption of money from this account is not possible & thus your fear of spending this amount on non essential requirements ‘ll not be there.

    In case of real need (read emergency), you may transfer using netbanking from dedicated account to normal SB account. Although it’s advisable to have a discipline in your banking operations.

    Thanks

    Ashal

    1. rmohan80@gmail.com says:

      Dear Ashal,

      I’m starting to think i’ll redeem part of my MF + stocks and build an emergency fund in cash in SB. That means, I’ll have to start over for my goal based savings at my age of 32. Would that be ok considering this is hard earned money over the past 10 years!

  13. bharat shah says:

    i try to answer your query about redeeming your mf investment. as per you market is good as you are in gain, but as such equity mf investment is for long period for long time goal , such as child education/marriage , your retirement, which are away 7-10 yrs. or so. and their performance year to year is to be watched comparing with peers or underlying index. only if the performance deteriorate , you should change. you should not try to time the market unless you feel the market is too hot, perhaps as in 2008 january.

    1. rmohan80@gmail.com says:

      Hi Bharath,

      Unfortunately (or fortunately) these are investments without any goal…maybe I can introduce that the goal is for an emergency fund for these?

      I’m right now only starting to start goal based investments…

  14. BanyanFA says:

    Hi Ram,
    I would first like to congratulate you in identifying the need for Contingency fund. 50% of the task is already over 🙂

    As suggested by Ashal, you should have around 2-3 months of expenses in your saving bank account. Whether it gets linked with a Auto sweep or not is not a matter of concern as these funds would be accessible on an instant basis.

    If you want, (I would suggest) increase your contingency fund to 12 months of living expenses and park the balance amount (12-3 months) into liquid funds. Growth or dividend option – it depends upon your tax bracket. If you are in 30% bracket, then I would suggest you to invest in HDFC Cash management – Treasury Advantage Fund – Dividend Option. It would limit the Dividend Distribution Tax to around less than 15%. Normal Liquid Funds face DDT upto 28% hence not suggested to go for a Dividend Option in such other funds.

    Regards
    BFA

  15. rmohan80@gmail.com says:

    Dear Ashal,

    I like your idea, however I feel silly asking this question and a little embarrassed too…somehow I’m not comfortable keeping the money in my SB as there is going to be some expense or the other that will come up.

    Which is why I want to push the money somewhere else where at-least a little effort is required. I used http://www.fundsinda.com and yes it’s as simple as clicking redemption and waiting for money to come to account, but little bit more difficult than going to ATM and withdrawing or using debit card…

    Anybody else feel this way or am I the only person who feels that keeping money in SB is going to be spent?

    Thanks,

    Ram

    1. rmohan80@gmail.com says:

      Adding to this point…maybe I break some of my mutual funds since market is good and most of my funds are in profit? Though my heart breaks ): at the thought of redeeming my funds!

  16. Dear Rmohan, for the given situation, I w’d ask you to first create a contingency fund of at least 3 months expenses in your SB account itself. As it’s meant for contingency only, do not worry for low or negative return.

    Once 3 month fund is at your disposal, you may start investing money in liquid funds.

    Please invest in Growth option for better tax adjusted returns if the holding period remains more than 1Y (which I hope ‘ll remain).

    Thanks

    Ashal

  17. rmohan80@gmail.com says:

    Additonally, I don’t want to go into the Auto Sweep facility suggested in some of the answers because of a number of reasons (taxation, my sweep-in account is HDFC while salary account is ICICI, I don’t want to setup a limit above which it gets converted to FD, rather I want every month some amount to go in as FD etc)

    So, please let me know if my plan of investing in a liquid fund is good?

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