Build a emergency fund through a liquid fund

Build a emergency fund through a liquid fund

Where should you keep your emergency funds?

Most of us have heard the old proverb about saving for a rainy day. So, how much money should be saved as contingency fund? Depending on the current income and obligations, one might need to keep in anywhere from three months’ to two years’ worth of expenses. Have you ever thought of getting reasonable returns without compromising too much on how quickly we could get our hands on the cash? Financial planners recommend that investors must build a contingency fund (typically 3-6 months of their expenses) through a liquid fund. In recent times, the liquid fund space has been witnessing some action due to excess funds remaining idle in their savings accounts post demonetization drive. Liquid funds are an attractive alternative to retail investors for parking funds lying idle in their savings bank accounts.

What is a liquid fund?

Liquid funds are an open-ended debt mutual fund schemes which invest the corpus into short term money market instruments like short term corporate papers, treasury bills and certificates of deposit with short maturity period (residual maturity not exceeding 91 days).

Key features of liquid fund

  • High level liquidity and nominal risk
  • No entry and exit loads
  • Different investment options like growth and daily, weekly, or monthly dividend
  • Tax efficient

When can you invest in Liquid Funds?

Emergency situation such as loss of job, markets crashing, medical emergency or any unfortunate event that come with an economic loss for some time. Sudden business expenditure or to address unforeseen circumstances or losses in a business

Taxation

Liquid funds are treated like other debt funds for taxation purpose. If you hold the fund for less than 3 years, then it is considered as Short Term Capital Gain (STCG). However, if you are holding for more than 3 years, then it is considered as Long Term Capital Gain (LTCG).

  • Short Term Capital Gain Tax for Debt Funds – It will be taxed as per your tax slab.
  • Long Term Capital Gain Tax for Debt Funds – It will be taxed at 20% with indexation benefit.

The tax treatment also differs with the growth and dividend plans that you opt for. Dividends received under liquid plans are not taxed at the hands of investors but fund houses pay dividend distribution tax.

Risk factor

Liquid funds come with some degree of risk, but if one invests in funds with good paper, the risk is minimal. Most liquid funds have a relatively low level of risk because of the lower maturity period.

Conclusion

Liquid funds extend the advantage of risk adjusted returns along with basic principles of accessibility and safety while maintaining a healthy contingency fund. Hence, it may be considered wise to park your surplus funds into liquid mutual funds and start an SIP to build a contingency fund.

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