The problem with your emergency fund

Summary: Your emergency fund is meant to be both safe and easily accessible, allowing you to tap into it quickly when life takes an unexpected turn. Yet many investors park this money in assets that make it difficult to access when they need it most. Here, we outline a simple three-layer framework to help you structure your emergency fund the right way.

I have invested my emergency fund as follows: 55 per cent in bank fixed deposits, 27 per cent in a balanced advantage fund and 18 per cent in a debt fund. Is this allocation appropriate, or should I make changes? – Anonymous

An emergency fund, as the name suggests, is one that you will need in the case of ‘emergencies’ or unforeseen circumstances. And so, the fund must be parked in investments that are low-risk, stable and highly liquid, helping you access it immediately and without uncertainty.

Unfortunately, many investors overlook this aspect and park their emergency money either in a single investment class or across assets that are highly volatile or illiquid. As a result, the money that was supposed to help them through their rainy days, remains inaccessible.

Thus, the smart way to make your emergency fund accessible is by dividing it into layers depending on how soon the money may be required.

Below is a simple, three-bucket framework to help you do this the right way.

Bucket 1: Instant access for urgent situations

The first bucket is for expenses that require immediate access to funds, such as medical emergencies. This bucket should typically hold one to two months of expenses or about 10-20 per cent of your emergency corpus.

Savings accounts or sweep-in fixed deposits linked to savings accounts work well here, since they allow instant access to money while keeping it safe.

Bucket 2: The core emergency reserve

The second bucket forms the heart of the emergency fund.

This portion covers expenses that may arise over the next few days or weeks. It should typically hold three to six months of expenses or around 50-60 per cent of the emergency corpus.

For this bucket, liquid funds are well suited. They invest in very short-term, high-quality debt instruments and aim to maintain stability while offering quick access to money. Redemptions are usually processed quickly and there is no penalty for withdrawing early.

Liquid funds also offer an advantage over traditional fixed deposits (FDs) from a tax perspective. Interest from FDs is taxed every year, whereas gains from liquid funds are taxed only when the investment is redeemed. This allows investors to defer taxes until the money is actually needed.

Bucket 3: The long buffer

Since an emergency is not foreseeable, your emergency fund should not be left to rust. This bucket ensures that you earn a minimum return over this corpus without taking any significant risk.

This layer can account for 30-40 per cent of the emergency corpus.

Traditional fixed deposits can serve this role in limited allocation due to flexibility and tax efficiency reasons. Short-duration debt funds can be complimented for this purpose.

What the reader’s allocation gets wrong

Coming back to the reader’s question, they have currently structured their emergency fund as follows:

• 55 per cent across bank FDs
• 27 per cent in a balanced advantage fund
• 18 per cent in a debt fund

There are two things wrong here: first, more than half of the emergency fund rests in bank FDs and second, investing in a balanced advantage fund.

Though bank FDs are safe, they are illiquid and not as tax efficient as liquid funds. Moreover, liquid funds offer marginally higher returns than FDs.

Why investing in balanced advantage funds is wrong? Despite having a dynamic equity exposure, these funds remain market-linked investments. Thus, their value fluctuates along with the market.

Emergency money should never depend on market conditions. If an emergency coincides with a market downturn, the investor may be forced to withdraw money at an unfavourable time. That defeats the very purpose of an emergency fund.

While the reader’s debt fund allocation may be acceptable, but only if it belongs to conservative categories such as liquid or overnight or short duration funds for the third bucket.

The right approach

A more sensible approach for the reader would be to gradually shift a significant portion of their FDs into liquid funds as they mature. If the FDs were booked recently, breaking a few of them may also be worth considering, depending on the penalty involved.

Sweep-in FDs linked to the savings account can continue as part of the first bucket. However, the balanced advantage fund allocation should ideally be moved to safer debt instruments.

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This article was originally published on March 10, 2026.