Emergency Funds: Don’t keep idle!
We always park a certain sum of money in our savings account as per our need, capacity and judgment for emergencies and contingencies; but most of the times, sadly, more than requisite funds are sleeping in our savings bank accounts. This may be due to lack of time or knowledge to focus on available financial opportunities. We also come across situations when arranging money is of extreme importance and we are not at all prepared for it; such as medical emergencies, a family wedding, a friend in need etc. We do have the money but not in liquid form i.e. it cannot be availed or arranged at the required time; it takes nearly a week to encash. Hence, we rather prefer the funds to stay idle in our savings account for such uncertain occasions. A savings account in India fetches an interest rate of nearly 4%, which is much below inflation rate. But we do not think much into it as we care less about earnings when planning for a contingency. What if we can achieve both, higher returns and quick liquidity by exercising financial prudence? Let us see how we can achieve this.
Have you heard about an overdraft facility? It is like availing a loan against some security and the most commonly and easily available overdraft without much paperwork is against fixed deposits. You may call it ‘Loan against Fixed Deposit’ as the fixed deposit receipt is required to be submitted to the bank as a security for this overdraft (OD) facility. Let’s try to understand this with the below numbers:
I. Let’s assume you have maintained a balance of Rs.5Lacs in your bank account for contingencies. Below table gives the interest you will earn out of it for the next 12months:
| Calculation of Interest Income on Savings Bank Account for the year | ||
| Account balance for 12months | Rs.500,000 | Interest earned on maintaining a balance of Rs.500,000 in your savings account for emergencies |
| Interest for 12 months (@ 4% p.a) | Rs.20,000 | |
II. Let’s suppose a friend is in urgent need of Rs.250,000 for meeting medical expenses of his family member. He commits to return this amount to you in three months.
| Calculation of Interest Income on Savings Bank Account for the year when money lent to friend | ||
| Account balance for 9 months | Rs.500,000 | Interest earned when part of your savings is used to pay for a medical emergency of a friend |
| Interest for 12 months (@ 4% p.a) | Rs.15,000 | |
| Account balance for 3 months | Rs.250,000 | |
| Interest for 3 months (@ 4% p.a) | Rs.2,500 | |
| Net Interest Income | Rs.17,500 | |
III. Now, you can exercise financial prudence and achieve the same with the help of an overdraft facility. The below table shows the fixed deposit you will have to maintain to achieve an effect like a savings account:
| Amount of Asset (Fixed Deposit) and Liability (Overdraft Account) | ||
| Fixed Deposit | Rs.500,000 | Maintaining the same amount in a Fixed Deposit gives a similar effect as overdraft limit is 90% of the FD amount |
| Fixed Deposit Interest Rate | 9% | |
| Overdraft Limit (90% of FD Amount) | Rs.450,000 | |
| OD Interest Rate (FD Rate plus 1%) | 10% | |
| Calculation of Income (Interest on FD) and Expense (Interest on Overdraft Account) for the year | ||
| Fixed Deposit | Rs.500,000 | Lending the amount of Rs.250000 to the friend by using the overdraft facility through a fixed deposit covers the emergency and gives us good value for the money earned |
| Fixed Deposit Interest Rate | 9% | |
| Interest Income for 12 Months | Rs.45,000 | |
| Overdraft Limit (90% of FD Amount) | Rs.450,000 | |
| Overdraft utilized for 3 Months for friend | Rs.250,000 | |
| OD Interest Rate (FD Rate plus 1%) | 10% | |
| Interest Expense for 3 Months | Rs.6,250 | |
| Net Interest Income | Rs.38,750 | |
Comparing the net interest incomes in points II and III; we see that there is a high amount to gain by maintaining a fixed deposit and utilizing the overdraft facility than to let funds stay idle in a savings account. Remember, this will work if you know that the nature of requirement is temporary and you will recover or arrange it soon enough! Happy savings!