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Should you use monthly savings meant for long term goals for short term unanticipated needs?

I have an unanticipated expense coming up during this year, but I don’t want to touch my emergency fund. I still have a few months till I need the money and I want to transfer some of my savings from equity SIPs to a debt fund temporarily. Does this make sense?

Question: I have an unanticipated expense coming up during this year, but I don’t want to touch my emergency fund. I still have a few months till I need the money and I want to transfer some of my savings from equity SIPs to a debt fund temporarily. Does this make sense?

Answer:

Honestly, as long as you are doing the right things, a slight diversion is OK, if not ideal. Also, congratulations on doing the right thing! You decided to save for an upcoming expense rather than think of taking a loan.

It’s a fact of life that we can’t anticipate all big expenses irrespective of how forward-looking we are. We make investment plans based on what we want to achieve and then invest in what is most appropriate for that objective

If you are a smart investor saving around 20%30% of his or her post-tax income, then you are likely allocating all your savings to the appropriate investments.

However, when all your savings are spoken for and something comes up then stopping your investments is unsuitable to your objectives. You have two options.

If it is an expense that is critical to your or your family’s well-being, then using your emergency fund can make sense.

Option 1 - Use your emergency fund

If it is an expense that is critical to your or your family’s well-being, then using your emergency fund can make sense. Go for it especially if you have good health insurance for yourself and your family. However, retain at least half of your emergency fund and don’t spend it all. Make sure your credit cards are not maxed out either. 

Option 2 - Divert existing savings/SIPs from equity to debt temporarily

You can shift a portion of your savings aligned to a long-term asset class to a short-term asset class, temporarily. While this is definitely not ideal, it also not the worst option.

From a practical perspective, this means, reducing your SIP towards your equity investments and moving the required percentage (what you need to fulfil your short-term obligation) to debt funds. Don’t completely stop your equity SIP, though. Just invest a lower amount than you were. This way you won’t completely derail your long term objectives.

There is only one rub. You are likely to take a significant tax hit if you are going to withdraw from your debt fund investments inside 1-3 years. If the amount is not too big and you have just a few months till when you might need the money, you might as well let the amount stay in a bank account.

Not all the time

However, this tactic shouldn’t become a habit. Your equity mutual fund investments are meant for the non-negotiables in life such as your retirement fund. Since your equity funds normally work over the decades to create a solid corpus, they offer some flexibility but don’t take it as a license to stretch your spends.

In fact, the practical solution is to create an indulgence fund using short term debt funds where you always have some money for unanticipated but non-critical needs. Think of it as an emergency fund for you and your family’s happiness. 

No one has a perfect financial plan in place and some flexibility is always needed. What matters is that you meet your obligations in a way that doesn’t derail the parts of your financial life that truly matter.

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