Do You Really Need A Large Savings Account Balance For Emergencies?
Author: Jai Prakash
We all need a reserve of money for our emergencies. Some call it emergency fund while others call it contingency fund. Typically, an emergency fund has to be big enough to cover at least 3-6 months of any family’s expenses. There are people who don’t have an emergency fund and there many who have an inadequate-sized emergency fund. But there are many who have a fairly large amount parked in bank savings accounts. While such people may be assured of the fact that they are prepared for emergencies, the truth is that they are getting hurt in other ways.
Invisible bite of inflationLarge amounts of money earmarked for emergencies and lying in a savings account are an easy target for inflation. With most savings account providing 4% annual interest and inflation typically being in the 5-6% range, and in many years much more, people are actually losing money.
The tax hit Your interest earnings in excess of Rs 10,000 annually are taxable. At the highest tax slab, this means you lose a third of the interest earnings. Or the 4% interest effectively becomes 2.76%. If you see the joint impact of tax and inflation, you will be spurred to do something about the slaughter of your money. So, what is the way out? You need an adequate-sized emergency fund but it has to be accessible and more rewarding as well.
The way out The trick is to keep in a bank savings only the amount of money that might be immediately needed. Rest can be parked in higher paying and more tax efficient liquid funds. In the last one year, liquid funds have provided a return of about 6.9% after tax.
Clearly, one needs to draw a balance between easily accessible money and ensuring that the overall growth of money doesn’t suffer in your quest to be well prepared for emergencies.
