Where to park emergency fund?

“Where to park my emergency fund?” is a question I see many people ask. This is also a question I was asking a few years back, but I did not get a satisfactory answer. In this post, I am going to write down my own answer to this question. My goal is not to give one single answer, but to give a matrix of options to choose from.

‘Emergency Fund’ by 401kcalculator.org • CC BY-SA 2.0 • flickr.com

a. Easy, transparent access

If you want the money to be accessible easily, without even having to consciously think about using the emergency corpus, add this as sweep deposit(s) to your primary account. If you run out of money in your bank account some day, your deposits will automatically liquidate to pay for your expenses.

Who is this good for?

• People who don’t want to think too much, but just want the safety of having an emergency fund.
• People who have family members who don’t want to (or cannot) think about drawing from different accounts or liquidating assets like mutual funds, fixed deposits, etc.

Maintenance strategy

Add the emergency cash to the primary bank account. Keep spending from that bank account without worrying whether you are drawing from the emergency fund or not. Every few months—say 6 or 12 months—review the surplus in the bank account + deposits. If it’s fallen below the amount you wanted to save, replenish it.

b. Easy, but non-transparent access

Open a separate bank account just for holding emergency fund. All cash in this account (including sweep deposits) is your emergency fund. This is a good option if you want the money to be accessible easily, but you want the use of the emergency fund to be a conscious decision.

Who is this good for?

• People who don’t want to accidentally dip into their emergency fund. For example, this is good if you want to know when all you had to access your emergency fund so you can make better financial plans.
• People with a “family emergency corpus” that anyone in the family can use. Open an either-or-survivor bank account in up to 3 family members’ names. Everyone uses their regular account for their day-to-day expenses. Anyone can use the joint account in emergencies.

Maintenance strategy

It’s very easy to tell how much money from the emergency fund has been used by just looking at the emergency account’s statement. Replenish the account as early as possible after every use (or periodically).

c. Harder to access, but more tax efficient

Interest paid to the money kept in banks is taxed every year irrespective of whether you used the interest or not. If you park the cash in mutual funds, you only pay tax if/when you use the money.

Using mutual funds is tax efficient, but the liquidity is severely limited compared to bank deposits. If you need a reasonably large sum at 4pm on a Friday, the earliest you can get access to cash is Tuesday! Or Wednesday if Monday happens to be a holiday.

Who is this good for?

• People who have other means to manage emergencies. For example, you are young and single, and you can ask your parents to lend you some cash.
• People who don’t like to manage bank deposits, such as calculating tax liability on realised + accrued interest.

Maintenance strategy

Same as option (b), but you also need a plan for (i) how you or your family members will redeem the mutual fund, and (ii) how you are going to manage the lag between placing a redemption order and getting cash in your bank account.

You can choose from a few mutual fund categories. Liquid funds are the safest; ultra short and money market funds are a tad bit riskier but may give about 0.5% more return. Gains from arbitrage funds are taxed even more favourably, but redemptions take 2 business days (vs 1 business day for debt funds).

Plug: Looking to open a new bank account with auto sweep-in and sweep-out? Check out my post Comparing auto-sweep accounts of 3 banks.

d. A corpus with 2 different buckets

There can be 2 kinds of emergencies.

1. The first category needs only a little bit of money, but you need it quickly. During the emergency, you may be preoccupied with more important things, and hence thinking about money then can be a hassle. Medical emergencies, a family member getting into an accident, a relative asking for an emergency loan, emergency car, house, appliance repair, etc are some examples.
2. The other category of emergencies needs a larger sum of money, but you’d need to spend it over a longer duration, say, a few months. Temporary loss of income is a typical example. In such cases, you usually have time to think and plan an asset liquidation strategy.

Let’s say you want to tackle these 2 kinds differently. You may want to optimise for liquidity and accessibility for the first kind and optimise for the highest return for the second kind. In this case, you can choose either (a) or (b) for the first part of your emergency corpus and (c) for the second part.

For the second part, it will be tempting to go with a hybrid mutual fund or a multi-asset mutual fund to potentially get a higher return. However, keep in mind that job losses often coincide with larger economic uncertainties. How would you feel if you lose your job right when your emergency corpus is down by 30% (because of the gloomy outlook in the market)?

Conclusion

The purpose of this post is to show a few solutions to inspire people to think of something that suits their needs and preferences. I hope that goal is accomplished. Everyone has unique needs. Make a plan that lets you feel the most comfortable, because living comfortably is the whole point of saving money.