How to Plan Your Emergency Fund (and Where to Park It in 2025)

Introduction

Just imagine that you are living happily with a stable job and family life. You bought the dream home recently. You are soon going to become a first time parent. Life couldn't get better. And suddenly the future that you saw yourself building suddenly crashes to a halt. Your company announces layoffs and you are one of the unfortunate people in the "list". As the only earning member, how do you service the home loan EMI? How do you cover all the baby expenses that are only weeks away? What if it takes you 3-4 months to find a new job? Well, you have a healthy emergency fund for precisely such times and you thank your first boss who advised you to start saving for emergencies all those years ago. 

How Much Should You Save?

An emergency fund, like the name suggests, is to take care of the essential expenses during times of peril. A general rule of thumb is that the fund should be able to cover anywhere between 6-9 months of monthly expenses. But this depends on your situation. The fund size would depend on whether you are married and both are earning members, number of dependents, type of employment - stable job, variable income, freelance, self-employed, your unavoidable liabilities like home loan EMIs, etc. Generally 6 months is enough in most cases. If both partners are earning members, 4 months could cover you. If  you have dependents, large liabilities then it is better to target a larger emergency fund. 

Steps to Build Your Emergency Fund

The first step is to calculate the required fund size. Also you need to fix a broad time frame when you will be able to achieve this fund. "I will have an emergency fund sometime in the next 5 years" is both vague and it also defeats the purpose - the emergency wont wait for 5 years. "I will put aside x amount every month and build the fund in the next one year to 18 months" is a better time horizon.  

Next comes deciding how and where you will park this amount. This is an important decision and we will see this is detail later. 

Next start saving every month and set aside small amounts. This can be automated through SIPs, periodic automated transfers from your bank, etc. Ideally, an emergency corpus needs to be built before starting investments journey. If you haven't till now, start immediately. Just because you haven't had the need to face any dire circumstances till now doesn't mean you can be complacent. 

Where to Park Your Emergency Fund in 2025

This is where one might go wrong. One way is parking the money in different baskets - savings accounts and other safe debt instruments. One might want to keep the whole corpus in savings accounts - that is completely fine. 

Distribution in different baskets is a good idea. A third in high interest savings accounts, a third in FDs and a third in low risk debt funds.  Also since not all banks offer partial liquidation of FDs in times of need, you might think of parking in multiple FDs - to reduce the penalties. To give an example, if you want to put Rs. 75000 in FDs, you can start 3 different accounts with Rs. 25000 in each, so in case you need Rs. 35000 for an emergency, you can liquidate 2 instead of the whole fund. You might want to check if your bank provides sweep in FD facility. Avoid long term FDs. 

There are multiple options for debt mutual funds - liquid funds with same-day or T+1 liquidity, ultra short duration funds, arbitrage funds. The arbitrage fund gives a benefit of tax treatment of an equity investment.

Criteria	Savings Account	Fixed Deposit (FD)	Liquid Mutual Fund	Arbitrage Mutual Fund
Pros	Highest safety (bank regulated) Instant access Good for very short-term	Capital protection Predictable returns Option for auto-renewal	Higher returns than savings No exit load after 7 days Very low risk	Tax-efficient (equity rules) Stable returns Good for 1+ year horizon
Cons	Very low returns (2.5–4%) Poor inflation protection	Penalty on premature exit May lag inflation	Returns not guaranteed Requires MF account	Returns depend on market arbitrage Slower liquidity (T+3)
Liquidity	Instant (ATM/UPI/NetBanking)	High, but penalty applies	1 working day (T+1)	3 working days (T+3)
Expected Returns (2025)	2.5% – 4% p.a.	5% – 7.5% p.a.	5% – 6.5% p.a.	6% – 7% p.a.
Tax Treatment	Taxable at slab rate Deduction up to ₹10,000 (80TTA) Seniors: ₹50,000 (80TTB)	Taxable at slab rate TDS if interest > ₹40,000 (₹50k for seniors)	STCG (<3 yrs) → slab rate LTCG (≥3 yrs) → 20% with indexation	Equity rules STCG (<1 yr) → 15% LTCG (≥1 yr) → 10% above ₹1 lakh

Common Mistakes to Avoid

The most important thing to keep in mind is that the purpose of this corpus is a safety net and not growth or wealth creation. Hence avoid investing in volatile, high or medium risk instruments. Do not chase returns here.

Another thing to avoid is parking in illiquid assets. The money should be available for use within one day or ideally on the same day. 

Not reviewing and reevaluating fund size regularly with changes in lifestyle and responsibilities can become a costly error in case of an emergency.

Conclusion

An emergency fund gives a peace of mind; a soft landing in the unfortunate case you come crashing down. Hence the only criteria to keep in mind are zero or low volatility, zero or low risk and immediate availability for use. Again, do not chase high returns for your emergency fund. Start building an emergency fund (and a good medical insurance) before other investments.