Reserve Fund: What Is It and How Does It Work?

 

In today’s world, with inflation hovering around 7%¹, financial planning is crucial for a safe and secure future. Most people put their excess savings into investment plans to build wealth for the future. But what about unplanned or emergency expenses? Most young people do not have sufficient liquid funds to dip into in times of need. In an emergency situation, they may have to pay to redeem funds from an investment or take a loan to meet unexpected costs. With some planning, you can alleviate these issues. A contingency or reserve fund encourages you to put money in highly liquid instruments that can be used whenever required.

What Is a Reserve Fund?

Reserve funds are a type of contingency plan. It could be a savings plan or any other asset you can liquidate quickly to deal with unexpected future costs. Often, these funds also help you deal with routine or planned expenses. For example, some people build reserve funds to help them purchase a home appliance, like a refrigerator, or to go on a holiday. Your reserve or contingency fund should offer you the opportunity to grow your money. A short-term savings plan could be a reserve fund as it keeps your money safely, provides interest on the amount, and lets you withdraw the funds as and when required.

How Do They Work?

A reserve or contingency fund encourages you to put away money periodically to build a significant corpus. These funds are held in liquid assets, ensuring you can access them in an emergency. Most individuals operate a savings plan as their reserve fund. Let’s assume Deepali gets her monthly income credited to a salary account. She puts 5% of her monthly earnings in saving plans as her contingency fund. She relies on the balance amount in the salary account for her daily and monthly requirements. After doing this for a few years, Deepali finds out her father is unwell, and she has to travel to her hometown to visit and look after him. She has to take unpaid leave and buy her tickets. She can use the funds in the contingency account to help with these expenses.

How to Set Up a Reserve Fund?

A reserve or contingency fund should help you deal with planned or unplanned expenses. To set up a contingency fund, you could put your money in short-term five-year savings plans. Apart from helping you build up a corpus, you can use the sum received on maturity to meet your planned expenses. You can also opt for a long-term ULIP for unplanned expenses. Your ULIP allows partial withdrawals after the five-year lock-in period, allowing you to access emergency funds as required. Both savings and ULIP plans provide life insurance coverage, ensuring your family has a reserve fund to rely on in case anything happens to you. To set up a reserve fund, you must check whether a savings plan or ULIP works better for you and your financial situation. Choose a plan that allows you to contribute regularly to build your corpus. Check for options that allow multiple withdrawals, allowing you some financial flexibility in difficult situations.

Benefits of a Reserve Fund

Some people do not think a contingency fund is necessary. Let’s look at three reasons why you should have a reserve fund:

• Easy Liquidity

  Most people today put their extra income into long-term fixed investment plans to create wealth for the future. Unfortunately, investment avenues come with distant maturity dates. Investors cannot always access the funds in these accounts, leaving them without the required cash when they need it most. Your contingency fund allows you to access the money whenever required, making it crucial in emergencies.

• Reduces the Debt Burden

  When a financial emergency arises, most people have to opt for loans to help them meet their needs. If you have a contingency fund, you do not have to worry about falling into debt. Instead, you can dip into your existing fund and replenish it later. Your reserve fund helps you avoid paying interest and EMIs to repay a loan.

• Grows Wealth

  You can earn significant returns on otherwise idle wealth with your ULIP or savings plan. You can build your contingency fund over time and generate a decent amount of additional wealth over and above your savings.

• Provides Life Coverage

  Savings plans and ULIPs provide you with life coverage along with short-term and long-term benefits. If anything happens to you, your loved ones will receive a payout, providing them with a financial safety net when they need it most.

A reserve fund is a crucial part of every sound financial plan. Along with insurance and investment plans, your contingency fund helps you deal with unexpected circumstances without causing significant financial stress.

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ARN: ED/07/22/28208