Q. I have a lump sum investment of ₹4.26 lakh in the HDFC Balanced Advantage Fund, with a current valuation of around ₹7.56 lakh. Is it advisable to use this as an emergency corpus, or would it be better to switch some amount to a liquid fund? Additionally, is it better to invest in liquid or arbitrage funds as an alternative to keeping surplus cash in savings accounts?
Response: The primary objective of creating an emergency fund is to have a separate corpus readily available to manage financial emergencies and other unforeseen exigencies. This fund should always be parked in financial instruments that offer the highest liquidity and capital protection.As mutual funds invest in market-linked securities, they are not immune to capital erosion. The risk of capital erosion in Balanced Advantage Funds is significantly high in the short term as these funds maintain a significant exposure to equities. HDFC Balanced Advantage Fund maintains an equity exposure (including hedged and unhedged components) of at least 65% at all times, to derive the benefit of equity taxation.
Among the various mutual fund categories, the risk of capital erosion is the lowest in liquid funds and overnight funds. Arbitrage funds also carry low risk and additionally offer the benefit of equity taxation, but its returns primarily depend on the arbitrage opportunities available in the equity market. Arbitrage funds work well only during uncertain and volatile market conditions.
I would suggest you park your emergency fund and short-term surpluses that have investment horizons of 1 to 3 years in the high-yield bank FDs of small finance banks like Unity Bank, Suryoday Bank, Ujjivan Bank, Utkarsh Bank and Jana Bank. These banks are offering FD yields of 8% or more, with much higher income certainty, liquidity and capital protection than liquid funds, arbitrage funds and balanced advantage funds.
Also, your FD closure proceeds will be instantly credited to your linked bank account. Liquid funds and overnight funds, on the other hand, have a TAT of T+1 working day for crediting the redemption proceeds to the linked bank account. While some fund houses offer instant redemption facilities to their liquid and overnight fund investors, SEBI regulations have capped this facility at Rs 50,000 or 90% of the investments, whichever is lower.
You should consider high-yield savings accounts of the above-mentioned banks for parking short-term surpluses with investment horizons of less than 1 year. Such savings accounts can also be used for parking your emergency fund, in case you have lower income certainty. These savings accounts offer interest rates of 3-4% p.a. for account balances of up to Rs 1 lakh, 5-6.25% p.a. for the balance component of Rs 1-5 lakh and Rs 7-7.5% for the balance component of Rs 5-10 lakh.Please note that you should maintain an emergency fund big enough to meet your unavoidable expenses, including your EMIs, for at least 6 months. If you are self-employed or have lower income certainty, increase the size of your emergency fund to cover those expenses for at least 12 months.
An edited version of this article was published in The Economics Times on July 22, 2024.
