Emergency funds: where to keep them for liquidity

The job description

An emergency fund has one job: to pay for a job loss, a hospital bill or an urgent repair without forcing you to sell equity or borrow at a high rate. Those events often arrive together with a falling market, which is exactly when selling equity hurts most.

That job sets the order of priorities. The money must be reachable within a day, it must not fall in value, and the cost of getting it out must be known. Return comes fourth. A fund that earns 1% more but might be 3% down on the day you need it has failed at the job.

How much

The usual range is three to twelve months of essential expenses, not income: EMIs, rent, groceries, school fees, insurance premiums and utilities. A two-income salaried household in a stable sector can sit at the low end; a single earner, a self-employed person or someone in a cyclical industry should aim higher. The emergency fund calculator works out a figure from your own expenses.

The options, measured

Here is what the low-risk fund categories earned over the past year, from the daily NAVs we hold, as of 1 October 2026. These are medians of Direct Growth plans:

The "worst fall" column is the largest drop the median fund's NAV has ever had from a previous high. It is the number that matters for an emergency fund, and it is why the list is ordered as it is: the further down the table, the more a fund can dip, even if briefly.

Overnight funds lend for one business day at a time, so they carry almost no interest-rate or credit risk. They earn the least of these categories.

Liquid funds hold paper maturing within 91 days. They earned about 1.2 percentage points more than overnight funds over the year, with only a tiny historical dip. Most fund houses offer instant redemption up to ₹50,000 or 90% of the folio value a day, whichever is lower, usually within minutes. A graded exit load applies for the first seven days, and the purchase cut-off is 1:30 pm. We looked at how tightly they cluster in liquid fund returns, October 2026.

Money market and ultra short funds earned a little more but hold longer paper, so their NAVs can move more. They suit money parked for several months, not the first call on an emergency.

Arbitrage funds returned the most, and are taxed as equity, which helps someone in a high slab. But they usually carry an exit load for redemptions within about a month, and their returns can dip in some months. They fit money you will not need suddenly; the arbitrage funds guide explains the mechanics.

Bank options

Savings account. Instant, works at 2 am, and earns little. The first slice of any emergency fund belongs here, because no fund redemption is faster than a debit card.

Sweep-in fixed deposit. Surplus above a set balance is moved into an FD automatically and broken back when needed. It earns more than savings with no market risk at all, though breaking an FD early usually costs a small cut in the interest rate. The FD calculator shows what a given rate earns.

Bank deposits are covered by DICGC deposit insurance up to a limit per depositor per bank, ₹5 lakh since 2020; check whether it has been raised before relying on the figure. Liquid and overnight funds carry no such insurance, though SEBI's rules on what they may hold keep the risk very low.

Tax changes the ranking

Interest on savings and FDs, and gains on liquid, overnight, money market and ultra short funds, are all taxed at your slab rate, whatever the holding period. So between a sweep-in FD and a liquid fund, the comparison is mostly about the rate and the access, not tax. One difference is timing: FD interest is taxed each year as it accrues, while a fund's gain is taxed only when you redeem.

Arbitrage funds are the exception, taxed like equity funds, which is why they look better after tax for someone in the 30% slab, provided the exit load and short-term dips are acceptable.

A structure that works

For six months of expenses:

• One month in a savings account, for the immediate problem.
• Two months in a sweep-in FD or an overnight fund.
• Three months in a Direct-plan liquid fund, in a separate folio from your long-term investments.

Two habits make it work. Test it once: redeem a small amount on a calm day and see how long it takes to reach your bank. And after you use it, refill it before restarting SIPs. The full reasoning is in our emergency fund guide.

What not to do

Do not keep it in equity because it is "only for a few months"; the emergency and the market fall tend to arrive together. Do not reach for credit risk or longer-duration debt funds for a slightly higher yield. And do not count a home loan top-up or a credit card limit as an emergency fund: that is debt you would be taking on at the worst moment.

This post is for education only and is not investment or tax advice. Fund returns are past returns computed from NAVs and do not predict future returns.