No financial plan is complete if it has no mention of an emergency corpus. An emergency corpus acts as shock absorber in times of distress and plays a crucial role in helping you buy time to let things fall into place during a crisis while preventing a spillover effect on your other financial goals. The economic upheaval caused by the coronavirus pandemic has not only served to drive home the point that you can never be completely prepared for any crisis but it has also highlighted how even small steps to secure your finances for any adversity can make a world of difference.

Experts recommend that as a thumb rule your emergency fund should have sufficient capital for you to be able to bear your essential expenses for a period of 6 to 12 months. This fund cannot be used for achieving your other financial goals like buying a car or vacations abroad but neither should it be perceived as building a sizable corpus as is the case with long term goals. The size of the corpus will also depend on your lifestyle and your existing financial liabilities.

Building an emergency corpus is not akin to saving and investing for other financial goals. Unlike retirement or children’s education you cannot stipulate a time frame as to when you would need your emergency corpus. Consequently, the underlying driving force for emergency corpus is not capital appreciation but they are safety and liquidity.

You have to ensure that the invested capital is safe and you can access it easily during the time of need. This automatically eliminates the option of equity investments for this purpose. In the short-term equity investments are highly vulnerable to market volatility triggered by domestic or international events. If you rely on equities for creating your emergency fund, there is no certainty that you will be able to exit from those investments at a profit in times of need. You may be forced to sell your investments at a huge loss if the market conditions are unfavorable at that point of time. Thus there is no point creating an emergency corpus which forces you to look for other financial resources during adverse events.

It is for this reason that liquid funds, which are a class of debt funds are considered the best investment avenue for the purpose of building a financial reservoir for rainy days. Liquid funds invest in short‐term assets such as treasury bills, government securities, repos, certificates of deposit, or commercial paper and as per SEBI norms, liquid funds can only invest in debt and money market securities with maturities of up to 91 days. The returns generated by liquid funds depend on the market price of the securities in the fund. Since prices of short-term securities do not fluctuate, it makes liquid funds ideal for emergency fund investments.

A liquid fund typically holds short-term securities that are of good credit quality, and as the name suggests highly liquid. Since investments are only made in short-term securities, risks posed by interest rate changes are negligible and its value remains fairly stable across different interest rate cycles. SEBI directives require liquid funds to only invest in listed commercial paper, and they can only have an overall exposure limit of 20% in a sector. SEBI norms also prohibit liquid funds from investing in risky assets and they must hold a minimum of 20% of their assets in liquid products. Only a small part of the income from liquid funds is generated via capital gains and as an investor you will mostly be earning through interest payments on debt holdings.

Another feature of liquid funds that make them a good fit for building a contingency fund is that there is no lock-in period and you can hold it for as long as required. And unlike FDs, you do not have to worry about paying a hefty tax on your interest income. As an investor in liquid funds, you will not be subjected to any taxes on your dividend income but your capital gains will be subjected to short term and long term capital gains taxes depending on how long you stay invested.

It is important to remember that liquid funds may not be wealth-creating products but they provide adequate safety and liquidity along with decent returns to help you create a solid emergency corpus.

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