Is your emergency fund safe enough?

Reader's question: For emergency funds, is it better to allocate 50-60 per cent to liquid and arbitrage funds and the rest to equity savings funds, instead of fixed deposits (FDs) due to taxation? – Dharmesh

An emergency fund has one job: to be there when everything else isn't. Not to outperform, not to optimise, just to show up, whole and accessible, on the day you need it most. That makes choosing the right fund for it a very different question from choosing any other fund in your portfolio.

The three non-negotiables of your emergency fund

First, the money must be accessible within a day. Second, its value must not fall when you need it. And third, the outcome must be predictable – no surprises at withdrawal.

Most fund categories, when held up against these three criteria, disqualify themselves fairly quickly.

The trap is that some categories look perfectly calm in normal times but buckle under stress. And stress, of course, is precisely when emergency money gets tested.

How different categories measure up

To see which funds are genuinely suitable, we looked at how often categories with low or minimal equity exposure (broadly under 40 per cent) delivered negative returns over one- and three-month periods. These are the windows during which emergency funds are most likely to be used. And the results are telling.

The table above tells a clear story. Liquid funds stand out as the strongest fit, with just 0.2 per cent negative one-month instances, and none over three months or a year. Overnight funds were even steadier, with zero negative instances across all periods. However, liquid funds offer a marginally better balance of return and accessibility. Money market funds are stable too, but liquid funds remain the cleaner choice.

Ultra-short duration funds offer better returns, 7.6 per cent on a one-year average, but with noticeably more short-term volatility: negative in 6.2 per cent of one-month periods and 2.7 per cent of three-month periods. That makes them a reasonable fit for the outer layer of an emergency corpus: money you may need in the future, but not the first amount you'd reach for.

Equity savings and conservative hybrid funds, on the other hand, fail the test decisively. While equity savings went negative in over a quarter of all one-month periods, conservative hybrids weren’t far behind. Arbitrage funds, though better, earned lower returns compared to the debt categories. These are not funds that belong anywhere near an emergency corpus.

Build it in layers

A well-structured emergency fund doesn't need to sit in a single place. Keep enough in your bank account or cash for immediate, day-zero needs. Park the core corpus in liquid funds. If the reserve is large enough that a portion won't be touched immediately, ultra-short-duration funds can hold that outer layer. This structure balances safety with practicality without asking any one bucket to do more than it should.

The only question that matters

When it comes to emergency money, the right question isn't which fund gives better returns or more favourable tax treatment. It's simpler: which fund is most likely to be there, intact, exactly when you need it? Seen through that lens, the shortlist narrows quickly, and liquid funds sit comfortably at the top of it.

Knowing which funds belong in your emergency corpus is just the start. The Value Research Advisor App helps you find the right funds for every corner of your portfolio.

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This article was originally published on April 01, 2026.