By Rina Nathani

While it is important to create an emergency corpus, it is equally important to park it in an instrument which earns higher returns than a bank savings account. A liquid fund is a good option as it primarily invests in money market instruments like certificates of deposit, treasury bills, commercial paper, call money, and term deposits. It holds a mandate to invest in debt and money market securities with maturity of up to 91 days only as per the regulatory guidelines. The entire portfolio of a liquid fund is marked to market daily to ensure that the declared NAV is ‘real’. The primary objective is to ensure that your investments are made prudently in safe and liquid instruments so as to earn slightly higher market-linked returns than the interest on a savings bank account.

That said, do not assume a liquid fund to be risk-free. In the past there have been instances of liquid funds holding toxic debt papers, exposing investors to high risk, and eroded investors’ capital. Hence, evaluate the portfolio characteristics of a liquid fund.

Government securities

Ideally, for your emergency fund or a rainy-day fund, look for a worthy Liquid Fund that predominantly holds government securities, quasi-government debt paper, treasury bills, and money market instruments issued by Public Sector Undertakings (PSUs). Besides, evaluate the average maturity, Yield-To-Maturity (YTM), and the Modified Duration (MD) of the portfolio. Investors should also look at the assets under management and the expense ratio of the scheme.

Evaluation process

In the evaluation process, do not excessively depend on the rankings assigned or simply go with the indicative risk-o-meter. It may serve only as a starting point to shortlist the funds. If you follow a prudent approach, the credit risk can reduce, and the capital will remain safe.

Always remember, clocking higher returns is secondary when you are planning to build a rainy-day fund or an emergency fund; first is safety! Hence, park your emergency fund in a liquid fund that prioritises safety (and liquidity) over returns. Never commit the mistake of holding your emergency fund in equities.

If you hold adequate money in liquid funds for a rainy day, you may not need to touch investments that have been assigned for vital financial goals and may never have to borrow from your friends and relatives. Make it a point to set aside hard-earned money for your emergency needs. Following the 12-80-20 allocation (i.e. 12 months emergency money in a liquid, 80% in an equity fund, and 20% in debt and fixed income instruments) is a good idea.

The writer is chief business officer, Quantum AMC.