Investing For A Rainy Day

Safety and liquidity, and not returns, should be the primary concerns while creating an emergency fund

- Avneet Kaur

The Covid-19 pandemic has made people realise the importance of building an emergency fund to deal with possible medical emergencies, salary cuts or job losses. Since the fund can be needed any time, it is usually invested in fixed rate instruments so that the returns can be known with certainty.

However, sharp interest rate cuts by the Reserve Bank of India (RBI) to combat economic slowdown have impacted returns of most fixed income investments. The widely popular liquid funds, too, have been hit. Some investment experts recommend arbitrage funds as an alternative to liquid funds. These funds buy shares in the cash market and sell an equal number of shares in the futures market, making money from the price difference between the two markets. Since the equity positions are fully hedged, market risk is largely eliminated. Can they be a substitute for liquid funds and other debt instruments such as bank fixed deposits (FDs)?

The Best Bet

Liquid funds and arbitrage funds are used to park money for the short term. Both have returned less than 3 per cent on a trailing basis in the past one year. Cumulative rate cuts of 250 basis points (1 basis point = 1/100th of a per cent) by the RBI since February 2019 have hurt returns from liquid schemes. In 2019, they had returned 6.33 per cent on an average. In 2020, this fell to 4 per cent.

Even though their returns have been similar of late, arbitrage funds have a taxation advantage. Sahil Arora, Senior Director,