Don’t Worry about Returns from your Emergency Fund

When it comes to putting money in an emergency fund, I suggest you don’t focus on returns. I know you may feel that your money should work hard and earn good returns. But when it comes to an emergency fund that is not how you should think. Do not go chasing after returns for your contingency funds.

So if not returns then what should you focus on? Liquidity and quick, easy access.

Here I don’t want to get into the discussion about the size of the emergency fund. I am sure you have read a lot about it. The generally quoted rule is to have about 6 month’s worth of expenses as an emergency fund. But think for yourself. Some of you have more dependents, fewer earning members, jobs in risky sectors, etc. So such people might find having a bigger contingency fund useful. Isn’t it? So for some, having a 6-month emergency fund is fine. For someone else, a 12-month buffer would be better. But I would say that having 6 months reserves is a bare minimum. If you don’t have it, then start building it up gradually. And when that is achieved, then you can increase it further based on your requirement and choice.

It is very important to make sure that your emergency fund is readily accessible when needed. Not just to you but to your family as well. You don’t want to put money in complicated instruments that your family members don’t understand and god forbid, if you are temporarily incapacitated in an emergency, the family is unable to get their hands on your emergency fund. Isn’t it?

So how much to put and where?

Here are some simple thoughts to consider this decision:

  • Always keep a part in Cash. Real hard cash. Your debit and credit cards, net banking, UPI, ATM, etc. may or may not work at all times due to technical issues or in case of infrastructural overload due to large-scale public crisis. I learned this lesson in Covid19. Cash is king. Really. How much cash to keep? Unless you have undisclosed cash at home(!), try to keep at least 1-2 month’s expenses worth in cash with you at all times.
  • You can also keep 1-3 month’s worth in Savings Account. If it’s a high-interest paying account, then it is fine. Just ensure that it’s a reliable bank to keep money with. You don’t want to face a bank run type of situation where ATMs dry up and RBI puts a curb on how much you can withdraw from your bank. Solution? Stick to comparatively safe banks that are among the top few in India to park money in your savings account.
  • Put a major chunk in simple bank fixed deposits. Something like 2-3 month’s worth of expenses. And stick to large and safe banks for fixed deposit in India. You might get attracted to higher interest being paid by many smaller banks. But I would say just be a bit careful about the financial stability of the institution itself.
  • You might also consider Sweep-In deposits in place of keeping money in a savings account or fixed deposits. These give liquidity of savings account and interest rates of fixed deposits.

If you are a conservative person and your emergency fund is not very large, then the above 3-4 options are sufficient for you. No need to be any more adventurous.

But if you want more, then you can also park some money in debt funds too. Note that all debt funds categories are not suitable for emergency funds. Limit your exposure to debt funds for emergency reserves to Liquid funds and ultra-short duration funds alone. Over the long term and hope you don’t need to touch your emergency fund, debt funds can be more tax-efficient. Do check debt fund taxation and how indexation reduces debt fund taxes. One more thing about debt funds and their use as contingency funds – I would strongly suggest you not to put all your emergency money in debt funds. Don’t do it. You never know when events like these might strike you at precisely the wrong time.

Also, just try to keep some extra money over and above your target emergency fund size as there would always be unseen expenses in times of emergency too.

And please don’t consider credit cards as an emergency fund. You can use it but it’s best to avoid depending on it as your sole source of an emergency fund.

Just ignore any temptation to go after high returns or tax efficiency. Do not go on asking questions about how to get a better return from my emergency fund? Returns really don’t matter when you are creating an emergency fund. Keep it very simple. Focus on liquidity and how easy it will be for your dependents to get that money in your temporary absence.

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So split your emergency corpus between cash, savings account, fixed deposits, and if need be (if you need a large contingency fund), then maybe a few categories of debt funds like liquid funds, etc. as well.

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