An emergency fund can be looked at as a metaphorical lock-safe, where an individual can park their surplus finances, to withdraw in case of an unforeseen event or an emergency. Therefore, the pre-requisite of such a fund is - highly liquid nature, which means that the funds invested may need to be easily accessible whenever required.
In such a case, a prudent investment strategy may be to invest in financial instruments that offer liquidity and can be redeemed instantly without a number of formal processes. While an individual may invest in the above-mentioned manner in liquid funds and ultra-short funds at their discretion, it is important to understand them in terms of their features and investment style.
Liquid funds are a type of open-ended debt fund that invest in debt and money market instruments such as certificates of deposits, commercial papers and treasury bills with a maturity of up to 91 days. According to the Securities and Exchange Board of India (SEBI) mandate, there is no applicable exit load if an investor chooses to redeem their invested capital after 7 days of investment.
Ultra-short term funds are a type of debt mutual fund that invests in debt and money market such that the Macaulay duration* of the portfolio is between 3 months and 6 months. This fund category has relatively more liquidity than short-term funds. They could be a suitable choice for investors who wish to invest their surplus funds and yield commensurate returns for a short period.
* The Macaulay duration is the weighted average term to maturity of the cash flows from a bond. The weight of each cash flow is determined by dividing the present value of the cash flow by the price.
Apart from the above-mentioned funds, investors may also consider investing in overnight funds that are a debt fund that invests in overnight assets, or debt and money market securities that have the maturity of one day. Such mutual fund schemes have an investment horizon of anywhere between 20 days to one month. It is recommended that investors take appropriate decisions with a focus on the safety of their finances rather than capital appreciation when it comes to putting together an emergency fund.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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