Emergency Funds
July 28, 2026
Rohan, a manager in a consumer-tech firm, had recently bought a new house on a home loan. He had utilized most of his liquid savings to pay for the down payment and had some money remaining in equity funds. Suddenly due to a restructuring in the company, he was laid-off. While his salary stopped, his home loan EMIs didn’t. Due to this he had to sell his equity holdings at a time when markets were low, putting brakes in his compounding journey.
What is an emergency fund?
Your emergency fund is money set aside for unplanned expenses. This fund stays untouched by both everyday spending and planned expenses. The purpose of this fund is not to provide capital appreciation, but to help during emergencies.
Why is an emergency fund required?
Emergencies can come anytime in life unannounced. They could occur due to serious medical issues, accidents, layoffs, natural calamities etc. While they are stressful in themselves, they could also be financially taxing which could further compound the stress. If you don’t manage them carefully, these unplanned expenditures can derail your financial planning like selling during unfavourable market conditions.
In the case of Rohan, had he set aside six months of monthly income as emergency funds, he wouldn’t have needed to sell his equity holdings at a loss.
While we can’t predict emergencies, we can be prepared for them financially to soften their blow by maintaining an emergency fund.
How much money to keep aside for emergency funds?
The size of your emergency fund varies based on your assets, liabilities, dependents, financial goals, etc. Here’s a thumb rule you can use for size of emergency fund with respect to average monthly income:
| Income type | Dependents | Emergency Fund Size |
|---|---|---|
| Stable | No | 3x monthly income |
| Stable | Yes | 6x monthly income |
| Variable | No | 6x monthly income |
| Variable | Yes | 12x monthly income |
How should emergency funds evolve over time?
When you start your investing journey, you should first look to build your emergency funds before investing in other assets. As your income increases and your lifestyle upgrades, you should keep increasing the emergency fund corpus. If you have dependents like elderly parents or children, you should further increase your corpus to cover their emergency expenses as well.
What instruments to use for an emergency fund?
You should use low-risk, highly liquid instruments for your emergency fund. Emergency fund could be deployed across:
| Type | Taxation | Typical returns | Advantages |
|---|---|---|---|
| Fixed Deposits | Income tax slab, every year on the interest earned | 6-8% (depending on the bank and tenor) | Near instant redemption, insurance up to 5 lakhs per bank by DICGC |
| Liquid Funds | Income tax slab, at the time of redemption | 6.5-7% | SEBI has streamlined Instant Redemption for liquid funds, allowing you to access up to ₹50K or 90% of your folio value (whichever is lower) within minutes, even on weekends |
| Arbitrage Funds | Equity taxation: <12M: STCG >12M: LTCG | ~6.5% | Higher post tax returns due to equity like taxation |
Deploying emergency funds in these instruments instead of keeping it in a savings account allows the fund to keep pace with inflation.
Conclusion
An emergency fund is a necessity for everyone, especially in today’s uncertain economy. Figuring out the right emergency fund size for you is critical along with deploying it in the right instruments. One should also be disciplined to use this fund only in emergencies, and not for regular expenses. Having an emergency fund gives you peace of mind.
Consult a registered investment adviser to understand the right size of emergency funds for you.