An emergency first is the first layer of defence in anyone’s financial portfolio against sudden financial requirements like medical emergencies, job loss, sudden payments etc. Though I had some years back written a post on emergency fund Link, when it comes to NRI, the situation is slightly different.
As an investment adviser, in course of my work of making financial plans for my NRI clients, checking whether the emergency fund is in place, is adequate and invested in the right places is one of the first checks I do.
It is my firm belief that while good returns on long term portfolio is necessary and makes one happy, that is not all: One also needs a peace of mind and a good night’s sleep that a decent amount set aside an emergency fund does that.
And a common gap that I find is that there is no thought process that has gone from the client’s end towards an emergency fund and therefore it is either inadequate or excessive. In this post, I wish to bring NRI reader’s attention towards contingency fund, and help her SET A PROCESS for creating and more importantly, maintaining it on a regular basis.
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What is an emergency fund & what is the objective?
Emergency fund is that chunk of money that you set aside for the rainy day – for emergencies, where sudden cash may be required. The underlying objective is very clear: there should be such an amount set aside in your portfolio that if you are bedridden or face a job loss and can’t find another job for the next six months, there should be NO problem for your family to meet the household expenses and pay the bills.
Such a contingency fund can provide a great deal of peace of mind to the head of the family as far as the finances are concerned.
How to calculate emergency fund requirement?
It is very simple. Sum up your household expenses, rent (if any), EMI for all your loans & any monthly insurance premiums and any other fixed payments you make on a monthly basis. Then, multiply it by 6 (if you wish, you can take a higher number, but in my view 6 is adequate). There, you have your contingency fund.
I see NRI clients who have parents in India – very old > 60 years: in that case, instead of applying for a separate insurance for them which is not only very expensive but comes with conditions like co-pay, I suggest such clients to pad up the contingency fund with a fixed amount say INR 10 lacs, which can function as a dedicated medical fund for parents. If you are in a similar situation, you can also work something like that.
How and where to invest the emergency fund money
So, when we speak about emergency fund, we are effectively speaking of liquid money which can be called at short notice & on which we are more concerned with availability at short notice rather than return on investment.
However, the issue I see in financial profiles that come to me for review is that there is no “segregation” within the investment portfolio, whereby you can say that this and this is my emergency fund. And this is where I chip in: I tag the investment assets to the three buckets – contingency fund, short term goals and long term goals (will do another post on short term/long term goals, in this post we’ll focus on emergency fund only)
Let us now come to the question on where to invest the emergency fund and according to me, following are the options:
#1: Overseas Savings Bank account:
This is the account where most of your fixed monthly obligations go out. So, as a principle, I suggest that around 2 months of expenses should remain in this account & for the rest, you can look at other options.
Two points of caution here that I would want to point out:
- It DOES NOT make sense to get into a comfort zone & keep entire emergency fund in this account because speak about USA or UAE or Australia or Singapore, you find almost NIL interest on savings bank accounts. While the primary intent on this money is easy access and not returns, we still want to look for opportunities where it can earn good return and be available at short notice and the good news is that such options are available (see below).
- Bigger reason for not keeping entire emergency fund in this account for certain jurisdictions like the UAE is that in case of your death, the banks freeze accounts and estate distribution happens as per the Sharia law. The Indian practice of nominee getting the funds do not happen in UAE. This is what I have read in news reports etc. Link & I am not an expert on this. In such a scenario, it is not a wise thing to keep huge chunk of funds in these countries & keep a bare min. of 2 month expenses and maintain the balance portion in India.
#2: Indian Bank Accounts (NRO & NRE):
FEMA rules are very clear that if you qualify as a non-resident as per FEMA, you have to re-designate bank accounts to non-resident. So, in all probability, you’ll have an NRO and an NRE account. In these accounts, there will probably also be a min. balance requirement and you’ll have money lying in these accounts.
Note of caution: This money will also qualify towards emergency fund ONLY IF you have an access to net banking facility to your account which can then allow you to seamlessly transfer money at a click of a button to your overseas account. If you don’t have access to net banking, FEMA requires you to every time fill a Form A-2 and submit to a branch which defeats the whole purpose of getting money at short notice so please be mindful of getting net banking access and conducting a test transaction before earmarking these funds towards emergency fund into these accounts.
Speaking about bank accounts, please also understand not to keep money idle in the account as it earns a meagre 4%, that too taxable in case of NRO. Better option is to create an FD which we’re going to discuss as our next option.
As far as taxation to NRI is concerned, it is given below:
- NRO: Interest is included in total income. TDS is applicable @30%. You should file a return and claim a refund/adjustment of this amount. DTAA benefit can be claimed to apply a lower TDS rate. Also read: Why Returning NRIs should continue filing tax returns even if no taxable income Link
- NRE: Interest is completely tax free till the day you return back to India and becoming a resident as per FEMA. No TDS applicable.
#3: Indian Fixed Deposits Accounts (NRO & NRE FD):
Now, NRE FD is one of the best investment options for NRI for long term financial goals. However, a certain portion of NRE FD can be earmarked towards emergency fund. So, what it does is that you have money ready at short notice AND that money earns you 7-8% tax free.
However, before you jump with joy, please understand that rules on NRE FD are very clear: anything withdrawn before one year will not earn you any interest. Mind you, 1 year is not a lock in period, only that you don’t earn interest.
And if you withdraw pre-maturely (for e.g. FD was due to mature on 10th September 2017 and you are withdrawing now), you’ll get interest as per applicable rates for the period FD was held + there will be a 1% pre-payment penalty.
So, if you see above restrictions, I agree on one thing: NRE FDs should ideally go towards the short term/ long term bucket and it is not the most perfect instrument as contingency fund. But the killer feature is its tax free status and this is why it can be considered.
Note of caution for host country taxation w.r.t NRE accounts: An NRI has to also see the taxation of investments in the country in which he qualifies as tax resident. For example, if you live and work in the USA, then even the interest from NRE bank account/fixed deposits which is tax free in India will be taxable in US tax assessment. So, for a US NRI, the comparative tax advantage on NRE FD is lost.
Yes, the approach you can follow to eliminate the slight shortcoming is that you earmark only those FDs towards this which have completed 1 year holding period. That way, even if FD is withdrawn, instead of zero interest, it will earn you albeit a little less due to pre-mature withdrawal.
#4: Liquid mutual fund schemes in India
And this brings me to the last but a very strong option and that is liquid MFs. A liquid fund is one type of debt fund which has a mandate as per SEBI regulations to invest only in debt securities maturing in next 90 days. Also, these funds invest in A+ & above paper. So, effectively, the credit as well as duration risk is highly minimised in these funds. When you speak of returns, these funds presently earn in range of 7-8%.
The slight dampener is taxation for NRI (and that is why I prefer NRE FDs) – the capital gain from these funds is taxable depending on the holding period – short term capital gain (holding upto 3 years) will be included in income & long term capital gain (holding > 3 years) is taxed at 20.60% along with indexation benefit.
The biggest advantage of liquid fund & why it can be counted amongst the “perfect” avenues for emergency fund is that it does not have any exit load/pre-payment penalty.
However, you should keep following things in mind before investing in liquid funds:
- If you try to select liquid funds on your own, you can get highly confused between liquid/ultra short term/short term etc. – on a conservative side, see the word liquid in the fund name for e.g. HDFC Liquid Fund. However, there is no stipulation from SEBI that liquid fund has to have liquid in the name. For example, Birla Sun Life Cash Plus Fund is a liquid fund.
- When choosing liquid funds, download factsheet to see its portfolio how much diversified it is, is the average maturity < 90 days how many securities are > A+, & then you can see whether scheme has beaten the benchmark or not. Usually people do opposite!
- Purchase it directly from AMC’s website for e.g. www.hdfcfund.com & select “DIRECT” plan and not regular plan. Direct plans are low on cost as distributor’s commission is not there.
- Select GROWTH option and not dividend option.
- If the amount is small say Rs. 10 lacs, don’t try and invest in 5 different liquid funds – that will be foolishness. Even a single fund will suffice in that case. Yes, if amount is say Rs. 25 lacs, then you can divide in between 2 liquid funds.
- Invest from NRE account (and not NRO account) to get redemption proceeds in your NRE account for onward repatriation outside India. If you invest through NRO, money will come back to NRO, and it will require some formalities to repatriate it out of India, which would then defeat the purpose of earmarking that money as emergency fund.
- If you need to redeem, try to redeem before 1400 IST which is the present cut-off time for liquid funds. If you put in a request before 1400 IST, money will be credited in your bank account next day (T+1). If you put in a request after 1400 IST, money will be credited day after tomorrow (T+2).
Other points on emergency fund:
- Credit cards and pre-approved personal loans are NOT emergency fund. If you think like this, you are in urgent need for financial education. Go read!
- Preparing a contingency fund is not a one-time activity. Every month, you need to spend a 2-3 hours to see the cash flow position and emergency fund. If you have recently withdrawn from the emergency fund, it is important to first replenish the same before making any long term investments.
- To people keeping 10 bank accounts & juggling their money between them, ask yourself: are you managing the finances or captaining a cricket team? If you love cricket, start finding time for it, as for finances, keep it simple to 2-3 accounts only.
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