Where to keep money in the emergency fund depends not only on the returns but also on how quickly you can withdraw the money when needed. Therefore, while choosing the right option, liquidity i.e. the facility of getting money immediately is most important, and only after that the tax or returns should be considered.
An emergency fund is a set aside amount of money that can be used to handle unexpected expenses, such as car repair or job loss, so that you do not need to take a loan. It acts as your financial security and helps you in difficult times without disturbing your long term investments.
In Mint's report on where to keep emergency fund, SEBI-registered investment advisor Avinash Luthria says that the meaning of emergency fund can be different in every situation, so it is important to understand it. If the situation is such where you need money immediately, like suddenly having to go to the hospital, then the most practical option is Fixed Deposit (FD). Although money is available in the savings account, most people do not keep a large amount in it. Mutual funds are not of much use in such cases because after withdrawal of money, it may take 23 working days for it to be credited to the account. In some cases, up to Rs 50,000 can be obtained quickly, but in a serious emergency this amount is not enough, hence FD is considered better for instant needs.
At the same time, if the emergency is such that you can get time of 2-3 days, then mutual funds can be a better option. In such situations, options like liquid fund, overnight fund can be considered, because these have good liquidity and can also be slightly beneficial from tax point of view.
As far as tax is concerned, it should not be the first priority while creating an emergency fund. If you need money immediately, the most important thing is to get the money quickly, tax can be seen later. Generally, FD is a good and simple option for people in low tax bracket, while people in high tax bracket can consider debt mutual funds, as these have the possibility of getting better returns after tax.
