Emergency fund: how much to keep, and where to keep it

Nobody gets excited about an emergency fund. It earns very little, and if all goes well you never touch it. But look at how most financial trouble begins: a layoff, a hospital bill, a family emergency, a broken laptop you need for work. The fund's job is to turn those events from crises into inconveniences.

How much is enough

The usual advice is three to six months of essential expenses. The word essential matters. Count rent, EMIs, groceries, utilities, insurance premiums, school fees, transport and any money you send home. Leave out dining out, travel and shopping, since those would stop in an emergency.

What counts as an emergency

A sudden loss of income, an urgent medical cost that insurance won't cover or will reimburse later, an urgent home repair, or travel for a family crisis. A sale, a gadget upgrade or a holiday isn't an emergency, however good the deal looks. Writing the rule down in advance helps.

Where to keep it

Three qualities matter, in this order: safety, easy access, and only then, returns. This money should not go into shares or equity funds. Markets tend to fall when the economy is weak, which is exactly when you might also lose your job.

• Savings account: instant access and safe, with the lowest interest. Good for the first month or two of expenses.
• Sweep-in or auto-sweep FD: money above a threshold in your account automatically moves into an FD and comes back when you need it. You get a better rate with the same convenience.
• Liquid or overnight mutual fund: usually a bit more than a savings account, and redemptions often arrive within a business day. Remember that debt funds aren't guaranteed. Overnight funds carry the least risk; check each fund's riskometer.
• Short FDs: fine for a portion, but breaking one early means a penalty.

A tiered setup works well: one month in the savings account, a few months in a sweep FD or liquid fund. The split gives you instant money for the first crisis and better returns on the rest.

Building it from zero

1. Open a separate account or fund folio and label it clearly. Money in your everyday account has a way of disappearing.
2. Automate a monthly transfer on salary day. Even ₹3,000 gets you somewhere.
3. Add every windfall. Bonuses, tax refunds, a cash gift. Splitting windfalls 50/50 between the fund and your goals is a good compromise.
4. Pause new investments if you have none at all, until the first month's worth is in place. Keep insurance premiums running, though.

If you already have debts

High-interest debt, such as credit card dues at 36 per cent or more a year, is a fire. A small emergency buffer of one month is still wise, so you don't fall back on the card the next time something breaks. Then attack the expensive debt hard, and return to building the full fund afterward. Our guide to paying off debt shows how.

After you use it

An emergency fund that has been used should be refilled before anything else. Treat it as a bill you owe yourself. A quick note of what you spent and why will also show whether the cushion was the right size.

A few quiet mistakes

• Keeping the entire fund in a high-return product that could lose value or carries an exit load.
• Counting your credit card limit as part of it. A limit is a loan, not a fund.
• Counting your PF or long-term investments as part of it. Withdrawing them can be slow, taxable, or both.
• Never reviewing it. When your expenses rise, your fund needs to rise too.

Interest rates and fund returns vary. Check current rates with your bank or fund house. Debt mutual funds are subject to market risks.

This article is for general education and is not personal advice. Found a mistake or an out-of-date number? Tell us and we will check it.