Choosing where to park your emergency fund is not just about returns—it is primarily about how quickly you can access the money when you need it. Here’s a look at the best instruments to put your emergency corpus – in terms of accesibility and also tax efficiency.
What is an emergency fund?
An emergency fund is a dedicated pool of cash designed to cover unexpected expenses—such as medical bills, car repairs, or job loss—without taking on debt. It serves as a crucial financial safety net, allowing one to handle crises without affecting long-term investments.
What is the best instruments to park your emergency fund?
To answer this, Avinash Luthria, SEBI Registered Investment Adviser at Fiduciaries, says that, “the term “emergency fund” is often used broadly, but it is important to understand that it can refer to different kinds of situations.” And accordingly, he clarifies
Immediate emergency: The first type is an immediate emergency — for example, if you need to rush to the hospital today and arrange funds instantly. In such cases, the most practical option is usually a fixed deposit (FD). While savings accounts are available, most people do not keep large sums of money there.
The reason mutual funds may not work well for such urgent needs is that redemptions typically take up to three business days for the money to be credited. There are exceptions — for instance, withdrawals below ₹50,000 in certain products may be processed faster — but in a serious medical emergency, ₹50,000 is often too small an amount.
So, for medical emergencies where immediate access to cash is critical, parking money in fixed deposits makes the most sense.
Emergency that can be slighly delayed: However, if the emergency is of a different nature and you can afford to wait for two to three business days, then mutual funds can be a better option. In such cases, liquid funds, overnight funds, or even arbitrage funds may be more suitable, especially from a tax-efficiency perspective.
Which is more tax efficient?
Tax efficiency should not be the first consideration when building an emergency fund. “If you need money today, where to get it from should be the primary though. In such cases tax efficiency is secondary,” Luthria.
However, for individuals in lower tax brackets, fixed deposits are perfectly fine for emergency fund parking, according to him. But for those in higher tax brackets, debt mutual funds and arbitrage funds deserve consideration, as they may offer better post-tax returns.
Which is the best option for those in the higher tax bracket?
Arbitrage funds is most attractive for those in the higher tax bracket. They are taxed like equity funds, with long-term capital gains taxed at 12.5%, making them more tax-efficient than traditional fixed deposits, which may be taxed at 30% (for high income individual.)
About the Author
