Where should you keep an emergency fund of ₹5 lakh: FD, savings account, or liquid fund?

You can allocate your ₹5 lakh emergency fund across a savings account, a Fixed Deposit (FD), and a liquid mutual fund. This ensures funds are available when needed, though it is important to understand the risks, interest rates, and withdrawal terms before investing.

In situations like sudden job loss, a medical emergency, or an unexpected major household expense, the most critical need is for funds that can be withdrawn immediately without hassle. This is why creating an emergency fund is considered essential. But if you have ₹5 lakh in savings, where is the best place to keep it? A bank savings account, a Fixed Deposit (FD), or a liquid mutual fund? Before choosing the right option, it is important to understand the benefits and limitations of each.

Keeping a portion of your emergency fund in a savings account can be beneficial. The biggest advantage is easy accessibility; whether you need to pay a sudden hospital bill or make an urgent payment, you do not have to wait to redeem investments. However, the interest earned on standard savings accounts is relatively low, so keeping the entire amount there might limit your potential returns.

The Fixed Deposit (FD) Option

Bank Fixed Deposits are suitable for those seeking a guaranteed, pre-determined interest rate on their funds. Interest rates vary depending on the bank and the tenure of the deposit. However, before investing in an FD, it is crucial to check the terms regarding premature withdrawal. Withdrawing funds before maturity during an emergency may attract a penalty or result in a lower interest payout. Therefore, parking your entire emergency fund in a long-term FD may not be the most convenient approach.

Liquid Mutual Funds

Liquid mutual funds primarily invest in short-term debt and money market instruments. While funds can be redeemed relatively quickly, there may be a time lag before the money actually reaches your bank account. Their returns are market-linked and come with no guarantees; therefore, they should not be considered entirely risk-free options.

How can you allocate ₹5 lakh?

According to Adhil Shetty, CEO of BankBazaar, a ₹5 lakh emergency fund could, for instance, be divided into three parts:

₹1 lakh in a savings account, to meet immediate needs.
₹2 lakh in a Fixed Deposit (FD), to earn interest based on fixed terms.
₹2 lakh in a liquid mutual fund, offering the flexibility to withdraw funds as needed.

This is merely an example; this specific allocation may not be suitable for everyone. The ideal ratio will depend on your monthly expenses, job stability, and risk appetite.

Priority: Safety, Not Maximum Returns

The objective of an emergency fund is not to maximize profits but to provide financial support during difficult times. Therefore, when choosing investment options, prioritize the availability of funds, the safety of the principal amount, and withdrawal terms. A balanced mix of savings accounts, FDs, and liquid funds can be utilized based on your requirements.