Where Should You Park Your Emergency Fund?

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This is the 3rd part of our ‘Emergency Fund’ article series. You can jump to the other parts directly if you wish: Part 1: What is an Emergency Fund? → Part 2: How Much Should You Have in Your Emergency Fund? Part 4: How to Create Your Emergency Fund? →

By now we know that an emergency fund is something that you can fall back on when you find yourself in an emergency like a job loss.

We also looked at how much you should have in your emergency fund.

Now the next logical question is - Where to park your emergency fund? This is what we will answer in this article.

We will also enlist some of the worst instruments to park your emergency fund so that your finances don’t get into trouble.

Ideal Features of Emergency Fund Instrument

If we have to list down the top 3 ideal features the right emergency fund instrument should have, they would be:

✅ Low risk/volatility: You don’t want to invest in high-risk investments that may be in losses when you need your emergency fund

✅ Quick and easy withdrawal: You don’t want the hassle of visiting your bank or filling out forms to get your money back over 4-5 business days

✅ Decent returns: Returns are not critical but should be optimised for if you have multiple low-risk options where your money is easy to access

Best Emergency Fund Instruments in 2024

The 3 features discussed in the last section can be found in 3 instruments:

Fixed deposits

Liquid funds

Arbitrage funds

Let’s look at each one of them in more detail.

By the way, these 3 instruments feature in our list of the best short-term investments too.

Fixed Deposits for Your Emergency Fund

Fixed deposits are our favourite instrument for emergency funds.

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Fixed returns. Quick and easy withdrawals. Incidentally, 2024 marks the comeback of high (8%+) FD rates.

Easy to Select

Selecting FDs is also not a chore or point of confusion as you can simply invest in the FDs offering the highest rates or your bank FD for convenience. The same cannot be said for liquid and arbitrage funds, the other two instruments on this list.

Insured by an RBI Subsidiary

FDs are insured up to Rs. 5 lakh per bank per account while liquid and arbitrage funds don’t enjoy this advantage.

These factors make fixed deposits the best instrument to park your emergency fund.

Liquid Funds for Your Emergency Fund

Understanding Low-Risk Liquid Funds

Liquid funds are a category of mutual funds that invest in bonds that will mature within the next 91 days.

Further, the bonds that liquid funds invest in are issued by reputed companies with a good history of repaying their loans. This makes liquid funds low-risk instruments.

Quick and Easy to Withdraw

It is easy to withdraw your money from liquid funds too. Once you place a withdrawal order, the money is credited to your bank account within 1-2 business days.

The Only Problem

Liquid fund returns are not exactly fixed. They are predictable but not fixed.

Similar mutual funds like low-duration funds, ultra-short duration funds and money market funds can be considered instead of liquid funds too.

Arbitrage Funds for Your Emergency Fund

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Arbitrage funds are special because they have the profile of fixed-income instruments but are taxed as equity instruments.

Equity instruments are taxed at either 10% or 15% depending on the holding period whereas fixed-income instruments (like FDs and liquid funds) are always taxed at your marginal income tax rate.

So, if you are in the 30% tax bracket, your gains from fixed-income instruments will be taxed at 30%. But your gains from arbitrage funds will be taxed at 10% or 15% depending on the holding period.

Exposed to Equity Risk

Since arbitrage funds deal in equity derivatives (like futures and options), they are exposed to equity risk. This risk is minimised by the arbitrage transactions - simultaneous buying and selling of instruments - that they engage in.

So, arbitrage funds are riskier than fixed deposits and liquid funds, the other two emergency fund options on this list.

Easy but Not so Quick Withdrawals

The withdrawals from arbitrage funds are easy but slightly slower (2-3 business days) compared to fixed deposits and liquid funds.

Because of the equity risk exposure (even though it is minimised) and the slightly slower withdrawals, arbitrage funds may not be the obvious emergency fund instrument for many. However, if you are in a higher tax bracket and okay with the not-so-harmful downsides of arbitrage funds, it is a great emergency fund option for you.

Comparing Fixed Deposits, Liquid Funds and Arbitrage Funds for Your Emergency Fund

Emergency Fund	Relative risk level	Withdrawal	Expected Returns in 2024	Who should consider
Fixed deposits	Lowest	Very Quick and Easy	6-9%	Right for most irrespective of tax bracket
Liquid funds	Low	Very Quick and Easy	7-8%	Low tax bracket investors (less than 15%) comfortable with mutual funds
Arbitrage Funds	Moderately low	Quick and Easy	7-8%	High tax bracket investors (more than 15%) comfortable with mutual funds

Worst Emergency Fund Instruments ❌

The worst instruments for emergency funds are those that score terribly on at least one of the ideal features of the best emergency fund instruments.

Simply put, an instrument is not right to park your emergency fund if it is:

Very risky/volatile

Difficult and/or time-consuming to withdraw

Offers very low returns

So, here are some of the most unsuitable options to park your emergency fund:

Instrument	Why is it a bad choice for your emergency fund
Stocks	Returns are not fixed, short term losses very much possible
Real Estate	Returns are not fixed, losses over any term very much possible, not easily and quickly convertible to cash
Equity Mutual Funds	Returns are not fixed, short term losses very much possible
Savings Bank Accounts	Returns are very low, fixed deposits/recurring deposits offer higher returns with same level of safety and liquidity
Government Bonds	Returns are not fixed, short term losses very much possible
Corporate Bonds	Returns are not fixed, short term losses very much possible, may not be easily and quickly convertible to cash
P2P Lending Products	High risk, may not be easily and quickly convertible to cash
Invoice Discounting	Very high risk, may not be easily and quickly convertible to cash
Asset Leasing	Very high risk, may not be easily and quickly convertible to cash
Cryptocurrencies	Returns are not fixed, losses over any term very much possible, may not be easily and quickly convertible to cash

Many other investment options may not be right to park your emergency fund. You should carefully evaluate each option based on risk, liquidity and potential returns.

Happy Investing!