How to use ones surplus money?

Should one use it to:

a. create an emergency fund?

b. invest for short term goals?

c. invest for long term goals like retirement?

d. repay existing personal loans / car loans / home loans?

This question is impossible to answer. Well almost impossible to give a single answer for all the readers at the same time.

However it is possible to say what should be the considerations…and the thought process . Most of the personal finance players will tell you that you should have 6 months expenses as an emergency fund (assuming this is in the bank..we are talking of a return of about 3% post tax).

If you have a short term goal (you have to make a down payment for a house, you need to pay for a child’s admission) this money could be lying in a short term debt fund (say post tax about 5%p.a.).

Your longer term goals – say 10 or more years – should be lying in an equity fund (say Cagr of 13% p.a.) .

If you have debt in the form of mortgages it could be in the cost range of  9-12% p.a.

My logic is very simple.

If you have a short term goal, by all means let this surplus remain in a liquid fund / bank fd / whatever you are comfortable with. Over a 90 day period THE RATE OF RETURN SHOULD NOT MATTER.

If you have no short term goal this money can be INVESTED for the long term like retirement or children’s marriage..knowing that the long term cagr of the equities is better than the rate at which you are paying to the housing mortgage company. DO NOT BOTHER REPAYING THE LOAN…if the total loan amount is about 2 times the total ctc of husband and wife….even 4 years is fine if both are planning to be continually employed in the forseable future.

Should one build a emergency corpus? do not be overly worried about this. If you have a good employer, parents who are well off, good credit cards with limits, adequate medical insurance, …do not worry too much about the emergency fund. Yes it is nice to build, but it is not the end of the world if you take time building it.

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  1. Follow up questions
    1) Should’nt emergency fund be in liquid fund compared to bank?
    2) What if the debt/loan is 90% of the CTC of the husband? should he still continue emi’s and not bother repaying?(emi is around 21%, investment is around 42%, expenditure is around 37% if take home)

  2. liquid fund/ bank is an individual call – from a return point of view it does not matter. I have it in debt fund / equities.

    emi is 90%….still if he has the guts to borrow this much he should also have the guts to do aggressive SIPs….see whether Net worth is going up and whether he/ she is comfortable with this % age of debt in his portfolio…

  3. Very good post Subra.

    Sometimes having an emergency fund lulls one into a false sense of security. Last year I was in urgent need of a sizeable amount for an emergency. It was 10 PM and needed the money before 6 AM. Had three times the amount in my bank account so was pretty relaxed about this. Went to the ATM and guess what – it ate the card !!!. Couldn’t get it out till 8 AM next morning.
    Had to turn to my dad whose card worked in a different ATM. Overall a humbling experience …

  4. It is been 8 yrs that am maintaining solid 3 months full pay into savings account as emergency fund. While am so peaceful, my bank RM and friends have got a problem with this high balance lying idle in account. I receive all kinds of suggestions and could keep most of them at bay so far.

    Credit card purchases and billing cycles started to confuse me a lot and then I switched over to pay thru debit card and became better in control of my spending.

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