How can you build your contingency fund via mutual fund investments?

Currently in a world fretting with high uncertainties, we surely ought to have a contingency fund in place to tide over the unforeseen. Melvyn Santarita, Analyst at Morningstar Investment Research India Private Limited says this corpus also serves as an excellent resource which can be tapped upon whenever there is an unexpected pause in the regular earnings.

Mutual fund investments that garner a higher return when compared to traditional investments, also coping with the inflationary parameter, make for a good bet to create a corpus that suffices as the contingency fund.

Common rule of thumb for an emergency/contingency fund

Santarita advises investors to maintain a contingency fund equivalent to six to nine months' worth of expenses. However, each investor needs to assess their own needs and adjust this amount accordingly

Suitable mutual fund categories to build contingency fund

Vijay Kuppa, CEO, InCred Money says that one can consider investing in short-term, ultra-short-term debt, or liquid funds, yielding ~7-7.5 per cent p.a. returns. These options offer the benefits of low risk and higher returns compared to a savings account, which can help you create the corpus in a shorter period. In emergencies, investors can also redeem their funds within 1-2 days. These funds typically lack exit loads, which means no cost on withdrawal.

“Regardless of where this fund is held, it should prioritize safety, liquidity, and have swift accessibility with minimal associated costs such as exit loads. Therefore, liquid and ultra-short-term mutual funds emerge as suitable category options for investors' contingency funds,” adds Santarita. 

These categories are structured to protect capital while ensuring quick availability of funds. Typically, investors can expect to receive their funds within a couple of days upon redemption.

Nevertheless, emergency funds are traditionally parked in savings accounts, which offer a 3-4 per cent p.a. return, failing to even keep pace with inflation.

Kappa underlines two strategies that need to be factored in for accumulating the corpus:

Invest a lump sum equal to 6 months of income (a common rule of thumb for an emergency fund) and allow it to grow until needed.

If you can't invest a lump sum upfront but know how much you need, consider SIPs. With SIPs, you invest regularly until you reach your target. Once you hit that mark, let your investment grow.