WHAT will you do if you need 50,000 for some emergency expense? Liquidate your FD or sell some units of your mutual fund. But it requires a certain process, which may take time. Even a credit card swipe may require you to pay next month which will create a dent on your savings. Ideally, any last minute need should be met by a contingency fund.
If you are a salaried individual your contingency fund should be equal to four to six months of your expenses. For example; if your monthly expenses work out to 15,000, ensure you have access to liquid cash of 60,000-90,000 at any point of time. For a self employed individual this number would increase to 1,20,000 as the cash flow is uncertain. Within the self employed individuals there are professions like acting in which the variability of income is very high. They should provide for a minimum of one year. Ideally you should lock in your excess cash in an instrument which comes with an easy exit clause.
If the size of the contingency fund is less than 1 lakh, look at a savings bank account. Although you earn only 3.5% compared to 10% on fixed deposits the interest income differential is not very high. Also, the excess cash is accessible.
If your contingency fund is 1 lakh-5 lakh you can look at sweep in accounts. These accounts are an amalgamation of the features of a savings-current account and a fixed-deposit account.
If your contingency fund is over 5 lakh, then you can look at liquid or liquid-plus funds. Liquid funds invest in low risk instruments like money market funds. Most funds have a lock in period of a maximum of three days to protect against and are redeemable within 24 hours. But the dividend distribution tax (DDT) is 27% (including the surcharge). Liquid plus funds come with lower DDT at 15% but the lock in period is almost a week. But for HNIs who park a lump sum money, this difference in DDT matters. If you are yet to build one, ensure that you have liquidity surplus of at least two months. Then you can gradually step up to build the kitty.
