Emergency fund planning is an important financial technique that all Indians should consider. It entails saving away a percentage of your salary to meet future unexpected bills or financial crises. This fund serves as a safety net, offering financial stability and peace of mind during difficult times. Explored here are the purposes and advantages of emergency fund preparation before doing a full comparison of two common choices for creating your emergency fund: life insurance plans and Systematic Investment Plans (SIP) liquidity.
Uses and benefits of emergency fund planning
Mental peace
Knowing you have emergency cash set aside decreases stress and worry, allowing you to focus on your long-term financial goals. For computing the accurate amount to set aside periodically, use an online monthly SIP calculator.
Financial security
An emergency fund serves as a safety net for you and your family in the event of an unforeseen expenditure such as medical bills, auto repairs, or job loss.
Avoiding debt
With an emergency fund, you are less likely to borrow or use credit cards to meet unexpected needs, preventing you from accruing high-interest debt.
Long-term financial goals
An emergency fund acts as a safety net, allowing you to continue working toward long-term financial objectives such as retirement planning or home ownership.
Opportunity seizing
Having an emergency fund allows you to take advantage of investing opportunities or make major life decisions without fear of financial disaster.
Independence
You won’t have to rely on others for financial support during emergencies, which will help you maintain your financial independence.
Now, let’s compare the two primary options for building your emergency fund: life insurance policies and SIP liquidity.
Liquidity
Life Insurance Policy: Life insurance policies often come with limited liquidity, especially in the initial years. You may need to wait for the policy’s maturity or a specific surrender period to access your funds without incurring significant penalties.
SIP Liquidity: SIPs offer high liquidity. You can easily redeem or partially withdraw your investments whenever you require funds, subject to the terms and conditions of the specific mutual fund scheme. This flexibility makes SIPs a suitable choice for short-term financial needs.
Nature of investment
Life Insurance Policy: Life insurance policies serve a dual purpose. They provide financial protection to your family in case of your demise, ensuring that your beneficiaries receive a predetermined sum assured. Additionally, a portion of your premium is invested, which may accumulate over time and provide returns in the form of bonuses or guaranteed payouts.
SIP Liquidity: On the other hand, Systematic Investment Plans (SIPs) are primarily investment tools. When you invest in SIPs, your money is pooled with that of other investors and utilized to purchase units of mutual funds. The primary objective is wealth creation over time, without any inherent insurance coverage.
Returns
Life Insurance Policy: Life insurance policies typically offer guaranteed returns along with bonuses. However, these returns are generally lower compared to market-linked investments, such as mutual funds. The conservative nature of these policies limits their growth potential.
SIP Liquidity: SIPs provide market-driven returns. While they may be subject to market volatility, they have the potential to offer higher returns over the long term, making them more suitable for individuals seeking wealth accumulation.
Risk profile
Life Insurance Policy: Life insurance policies are considered lower risk investments due to their guaranteed returns. However, this lower risk is accompanied by limited growth potential, which may not keep pace with inflation.
SIP Liquidity: SIPs carry a higher level of risk due to market fluctuations. While they offer the potential for higher returns, the value of your investments can vary significantly with market performance. Investors should have a higher risk tolerance when considering SIPs.
Tax benefits
Life Insurance Policy: Life insurance policies are eligible for tax benefits under Section 80C of the Income Tax Act for the premium paid. Additionally, the maturity amount is exempt under Section 10(10D), provided certain conditions are met.
SIP Liquidity: Tax benefits are also available for certain mutual funds under Section 80C of the Income Tax Act. However, the tax benefits associated with SIPs may not be as extensive as those of life insurance policies.
Lock-in period
Life Insurance Policy: Life insurance policies typically have longer lock-in periods, during which withdrawals or surrenders may result in reduced payouts. These lock-in periods vary depending on the type of policy and terms.
SIP Liquidity: SIPs do not have a specific lock-in period, providing investors with flexibility. However, some mutual fund schemes may have exit loads or penalties for early withdrawals, so it’s essential to check the specific terms of the fund.
Purpose
Life Insurance Policy: The primary purpose of life insurance policies is to provide life cover with an element of savings or investment. They are often chosen to secure the financial future of dependents in case of the policyholder’s demise.
SIP Liquidity: SIPs are designed for wealth creation and liquidity. They are focused on helping individuals accumulate funds over time to meet various financial goals, including short-term needs and long-term objectives.
Premiums and contributions
Life Insurance Policy: Life insurance policies require regular premium payments as per the policy terms. Missing premium payments can lead to policy lapses or reduced benefits.
SIP Liquidity: SIPs allow investors to make flexible contributions based on their financial situation. You can choose the investment amount and frequency that suits your needs, making it adaptable to changing circumstances.
Access to funds
Life Insurance Policy: Life insurance policy offers limited access to funds, subject to the policy’s terms and conditions. Withdrawals may result in reduced benefits or surrender charges, especially during the policy’s early years.
SIP Liquidity: SIPs provide easy access to funds, allowing investors to redeem or switch their investments partially or fully based on their financial requirements, with minimal restrictions.
Both life insurance policies and SIP liquidity can play a role in your emergency fund planning. The choice between them depends on your financial goals, risk tolerance, liquidity needs, and investment horizon. It’s essential to assess your individual circumstances and consult with a financial advisor to determine the most suitable approach for your emergency fund and overall financial well-being. A diversified approach, combining the strengths of both options, may also be worth considering achieving a balanced financial strategy.