Mutual Funds

Fund Query: How to build an emergency corpus with liquid funds?

Aarati Krishnan | Updated on June 06, 2021

I am a 24-year-old finance professional who has just started working. As part of my financial planning, I would like to make a satellite portfolio or an emergency corpus fund. I believe liquid funds are an appropriate option for such savings. Can you please guide me on well-performing liquid funds or other investment options other than liquid funds that will be best suited for my strategy?

Sanjay Kaimal

You are quite right to start your financial planning exercise with creating an emergency fund. But a satellite portfolio is not quite the same thing as an emergency fund. A satellite portfolio is typically a tactical portfolio that you hold in addition to a core portfolio that is intended to meet your long-term goals. Usually, satellite portfolios are constructed to have limited allocations to high-risk, high-return assets or to short-term opportunities offered by the market. By riding on such opportunities, the satellite portfolio is expected to provide a booster to the returns from your long-term core portfolio. Unlike your core portfolio which must not be churned too often, the satellite portfolio can be churned actively to adapt to market conditions.

Coming to the emergency fund, it would be good to start the exercise by estimating your monthly living expenses. The emergency fund should ideally amount to about nine months’ worth of expenses. You can start with a fund that covers six months’ expenses and add to it as your income and savings build up. While choosing parking ground for your emergency fund, it is necessary to prioritise safety of capital, and the ability to immediately withdraw your money, over earning high returns.

Therefore, liquid funds must not be the only the product you consider for parking this money. While liquid funds allow you to withdraw up to ₹50,000 within the same day for emergencies, if you would like to redeem higher amounts, you may have to endure a one to two-day wait for the redemption to be processed and proceeds to be credited to your bank account. Non-working days can stretch the amount of time it takes for the redemption request to be processed. Some emergencies may not allow for such extra time. Therefore, we suggest that you spread out your emergency fund between different avenues. Going by recent experience, it would be ideal to have some hard cash component in this fund (say, one month’s expense) and split the remaining between bank FDs and liquid funds. You can perhaps park four months’ worth of expenses in a bank FD and the rest in liquid funds.

In the case of bank FDs, again, do not go for banks that offer the highest rates as they may feature a weaker financial profile. It is best to stick to systemically important banks even if their interest rates are lower. While choosing your bank FD product, make sure it allows premature withdrawal (even with penalty), online operations, and facilitates online breaking of the FD with the proceeds being immediately credited to your savings account.

Liquid funds such as Axis Liquid, SBI Liquid and Aditya Birla Sun Life Liquid are options to consider. But you should be aware that after the recent fall in rates, liquid fund returns have moderated to an annualised 3-4 per cent, which may not be very superior to a savings bank account. You can consider other safe debt fund categories such as floater funds, banking and PSU debt funds for this money, provided you can ensure the portfolio is in sovereign or AAA/A1 plus rated instruments.

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Published on June 06, 2021

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