Emergency Fund Planning: How Much and Where to Keep It?

A few months ago, one of my clients called me in a bit of a panic. Her company had suddenly announced a round of layoffs, and while she was fortunately safe, the thought of “what if” kept her awake at night. She asked me*“If something unexpected happens, do I have enough to fall back on?”*

That’s when we started talking about the most underrated pillar of financial planning: the emergency fund.

Why an Emergency Fund Matters?

Think of it as a financial cushion. It’s not glamorous like high-return stocks, nor as exciting as property investments. But when life throws a curveball; a job loss, a medical emergency, or even an unplanned car repair, this is the fund that lets you sleep peacefully at night.

How Much Should You Have?

There’s a thumb rule that works well for most people: keep 3 to 6 months of your essential expenses aside.

• For someone living with family and fewer responsibilities, 3 months may be enough.
• For those with dependents, EMIs, or unstable income (like freelancers), 6 months or even more is safer.

The idea is simple: ask yourself, “If I had no income tomorrow, how long could I manage my basics – rent, groceries, utilities, EMIs, without breaking into my long-term investments?” That’s your benchmark.

Where Should You Keep It?

Now comes the real question: where should this money sit? Remember, an emergency fund is not about chasing high returns. It’s about safety, liquidity, and access. Still, the instrument you choose matters, because each comes with its own pros and cons.

1. Savings Account

The simplest and most convenient. Funds are instantly available, and you don’t need to worry about paperwork. But interest rates are low, and because the money is so easy to reach, many people end up dipping into it for non-emergencies.

2. Fixed Deposits (FDs)

Traditional, but not always practical for emergencies. Breaking a normal FD before maturity comes with penalties. A smarter alternative is a sweep-in FD, which links to your savings account. Your money earns FD interest but can be accessed automatically if your balance dips. One catch: FD interest is taxed on a notional basis, whether you withdraw it or not, the tax has to be paid.

3. Liquid Mutual Funds & Arbitrage Funds

• Liquid Funds usually offer better returns than savings accounts, with redemption in about 24 hours. However, short-term capital gains (STCG) are taxed at your applicable income tax slab. Exit loads vary by fund, but typically it’s 0.0070% if redeemed within 6 days.
• Arbitrage Funds are an interesting alternative. They deliver similar returns to liquid funds but are taxed as equity. This means:
  • STCG (if redeemed within 1 year): flat 20%.
  • LTCG (after 1 year): 12.5%, with an exemption of ₹1.25 lakh per year.
  • Exit loads: generally 0.25% if redeemed within 30 days, but this can vary across funds.

For investors in higher tax brackets, arbitrage funds can sometimes be more tax-efficient than liquid funds.

The key is balance: not locked away, but not so easy to swipe away either.

For NRIs, the approach needs to be a bit more strategic because you’re balancing life across two geographies. The key question is: “If an emergency strikes, where will I need the money abroad, in India, or both?”

A smart way is to split your emergency fund:

• Local bank account (country of residence): Keep at least 3–4 months of living expenses in your local savings account or short-term deposit. This ensures immediate access for rent, healthcare, or daily expenses without worrying about international transfers.
• India-based accounts/funds: For responsibilities back home; family needs, property expenses, or medical support, you could keep a portion in:
  • NRE/NRO savings accounts (easy access).
  • Short-term fixed deposits with premature withdrawal options.
  • Liquid/Arbitrage mutual funds for slightly better returns, redeemable within a day or two.

This way, you’re never caught off guard, whether the need arises overseas or in India.

How to Make It Happen?

The biggest hurdle in building an emergency fund is consistency. Life expenses creep in, and we push this “later.” A simple hack is to automate it. Set up a monthly transfer (like a SIP) into a designated savings account or liquid fund. Over a year, you’ll be surprised how the fund quietly grows.

Wrapping Up

When my client and I did the math, she realized she had just about two months of expenses saved. We worked on redirecting a small part of her monthly income into a liquid fund, and within a year, she had built a solid six-month cushion. Thankfully, she hasn’t needed to use the fund so far. But just knowing it’s there has lifted a huge weight off her shoulders. That sense of financial safety is what makes an emergency fund truly invaluable.