Debt Mutual Funds Vs Bank FDs – Where to invest emergency fund?

Where to invest or park our Emergency Fund? Between Debt Mutual Funds Vs Bank FDs, which is best suitable for parking the emergency fund?

The biggest question for many of us is to at first identify our emergency fund. Once it is identified, then the confusion is where to PARK (NOT INVEST) the emergency fund. Before proceeding further to understand the pros and cons of both products, let us first understand the purpose.

Purpose Of Emergency Fund

You must know the purpose of the emergency fund clearly. This to be frank reduces your confusion about choosing the products. When it comes to emergency funds, two things matter to us a lot and they are as below.

# Emergency Funds should be easily accessible as early as possible without any hassle or waiting period. Hence, liquidity is the biggest criterion before you choose a product. In fact, the emergency fund should be accessible for you 24*7 without even any holidays.

# It should be at the highest safety place. Few actually look for a return on investment while choosing a product to park their emergency fund. If you chase returns and end up in negative returns, then it will fail to serve the purpose of an emergency fund. Hence, rather than returns, you have to look for safety as a priority and accordingly choose products.

Debt Mutual Funds Vs Bank FDs – Where to invest emergency fund?

Considering the above two important aspects, let us try to understand the pros and cons of Debt Mutual Funds vs bank FDs to park your emergency fund.

Debt Mutual Funds –

There are various categories of debt mutual funds are available in the market. The lowest risky product among them is Overnight Funds. In the case of Overnight Funds, the fund manager holds the securities for a day. Hence, they are considered as least risky debt funds. You no need to look for which BEST OVERNIGHT FUND to park. Instead, as I mentioned all overnight funds follow the same strategy of one-day holding, you just invest in any fund that suits to you. Currently, there are 34 Overnight Funds available. Don’t invest in Overnight ETFs as liquidity may be a concern due to low-volume trading.

Below is the complete list of Overnight Funds with their last one-year returns, expense ratio, inception date, and AUM.

You can choose any one fund among these and can invest. Don’t look at past year returns. They are showing fantastically mainly because inflation inched up, the interest rates went up and because of that long-term bonds hit a lot and short-term bond securities generated fantastic returns. However, as I have mentioned above, rather than looking at returns the concern is more of SAFETY. Hence, I suggest Overnight funds.

The other category of debt mutual funds that you can explore to park your emergency fund is Liquid Funds. Liquid Funds usually invest in debt securities which mature within 91 days. As the maturity of the securities is just 91 days, they are less volatile compared to other categories of debt funds (a bit risky than overnight funds).

Should I blindly choose any liquid funds like how I recommended above in the case of Overnight Funds? NO…In the past, there were instances of Liquid Funds where they performed terribly because of fund managers’ risk. You can refer to my old post in this regard (Is Liquid Fund Safe And Alternative To Savings Account?). Hence, rather than assuming all liquid funds are safe, you have to look at the portfolio of the Liquid Funds and decide on this. Currently in India, there are around 36 liquid funds available (as I mentioned about Overnight Funds, here also avoid ETFs.)

My preference is Parag Parikh Liquid Fund or Quantum Liquid Fund (Not QUANT). However, you are free to choose the fund of your choice. But as I mentioned above, all Liquid Funds are not SAME and SAFE. Try to look at the portfolio of the fund and then take your own call.

Don’t experiment with any other categories of debt funds. If you chase returns, then you may end up with risk. Hence, in the case of debt mutual funds, use these two categories only to park your emergency fund.

What about the SAFETY of these two mutual fund categories?

As I mentioned above, Overnight Funds are risk-free but don’t expect the same from Liquid funds. In Liquid Fund it depends on which fund you choose.

What about the LIQUIDITY of these two mutual fund categories?

Liquidity is the biggest hindrance of these two categories of mutual funds. Currently, few funds offer instant redemption of up to Rs.50,000 or 90% of your portfolio (whichever is lower) per day. The limit shall be applicable per day per scheme per investor., However, if you need money beyond this, then you have to wait for the normal process of redemption which may take 1-2 days of time.

What about the TAXATION of these two mutual fund categories?

After 1st April 2023, the returns are taxed as per your tax slab (Refer to my post “Debt Mutual Funds Taxation From 1st April 2023”). Hence, there is no great advantage to investing in these debt funds if you are looking for taxation.

Bank Fixed Deposits

Bank FDs are simple products that can be handled easily. Hence, my preference for parking your emergency fund is always Bank FDs. However, you just have to follow these points.

• As I mentioned, choose a bank that is trustworthy rather than chasing returns. Avoid co-operative banks, small finance banks, or NBFCs to park your emergency.
• Book the FDs online mode as it will be easy for you to liquidate.
• If your emergency fund is say Rs.6 lakh and monthly expenses around Rs.1 lakh, then rather than booking a single FD, make sure to have 6 FDs of Rs.1 lakh each. This to a certain extent reduces the premature withdrawal penalty cost. If you book a single FD of Rs.6 lakh and you just need Rs.1 lakh, then you have to liquidate the whole FD and the penalty will be on Rs.6 lakh FD. Instead, if you booked FDs in small amounts then your cost of premature penalty will be reduced.
• As in banks, the maximum amount secured is Rs.5 lakh, if your emergency fund is beyond that then invest the remaining amount in your spouse’s name.
• If your bank offers sweep in FD, then use the same.
• If you have a home loan OD like SBI MaxGain or Bank Of Baroda (“Baroda Home Loan Advantage”), then park your emergency fund there which is more cost-effective.

Conclusion – As I mentioned initially, the purpose of emergency fund PARKING (NOT INVESTING) is to look for the highest liquidity and safety. Considering these two aspects, I prefer Bank FDs over Debt Mutual Funds. However, you are free to choose your choice. But make sure not to forget the purpose of the emergency fund (liquidity and safety).

If you wish to know more about Debt Mutual Funds, then refer to our series of articles on this aspect in “Debt Mutual Funds Basics“.