Every financial advisor will tell you to maintain an emergency fund — a pool of money set aside for unexpected expenses. The standard advice is to keep 3 to 6 months of living expenses in a savings account or liquid fund.

But here is a question many investors grapple with: does it make sense to keep a large amount of money idle in a savings account when it could be invested and growing?

This is where loan against mutual funds enters the picture — as a potential alternative or complement to a traditional emergency fund.

Let us explore both approaches.

The Traditional Emergency Fund

An emergency fund is money kept in a highly liquid, low-risk form — typically:

• A savings bank account
• A liquid mutual fund
• A short-term fixed deposit

The goal is simple: if something unexpected happens (job loss, medical emergency, urgent repair), you have money available immediately without selling your long-term investments.

Advantages

• Instant access — Savings account money is available 24/7 via UPI, ATM, or net banking
• No borrowing cost — It is your own money, so there is no interest to pay
• Peace of mind — Knowing you have a cushion reduces financial stress
• No market risk — A savings account balance does not fluctuate

Disadvantages

• Low returns — Savings accounts earn 2.5% to 4% per annum, well below inflation
• Opportunity cost — Money sitting idle could have been invested in equity or debt funds earning significantly higher returns
• Large idle pool — 6 months of expenses for a family could mean ₹3-6 lakh sitting in a low-return instrument

Loan Against Mutual Funds as a Liquidity Backup

Instead of keeping a large cash reserve, some investors prefer to keep their money fully invested and use loan against mutual funds as their emergency liquidity mechanism.

The idea: if an emergency strikes, you borrow against your mutual fund portfolio for a short period, handle the emergency, and repay the loan when your cash flow normalises.

Advantages

• Money stays invested — Your entire corpus earns market-linked returns instead of sitting in a savings account
• Quick access — Many LAMF platforms disburse loans within hours
• Lower effective cost — If your investments earn 10-12% and the loan costs 10-11%, the net cost is minimal
• No permanent impact — Your units remain invested; you just pay interest for the period you borrow

Disadvantages

• Not instant — While fast, it is not as immediate as a savings account debit. You may need a few hours to a day
• Interest cost — You pay interest on the borrowed amount, unlike an emergency fund which is free
• Margin call risk — If markets are down (which is often when emergencies feel worst), your collateral value drops and you may face margin calls
• Minimum thresholds — You need a minimum portfolio size to qualify for a loan

Comparing the Two Approaches

The Hybrid Approach: Best of Both Worlds

In practice, the smartest approach is often a combination of both:

Tier 1: Small Emergency Fund (1-2 months of expenses)

Keep a small amount — perhaps 1 to 2 months of expenses — in a savings account or overnight/liquid fund. This covers minor emergencies and gives you instant access: an unexpected medical bill, urgent travel, or a car repair.

This amount earns low returns, but it is small enough that the opportunity cost is manageable.

Tier 2: Loan Against Mutual Funds (for larger needs)

For larger emergencies — 3 to 6 months of expenses — instead of keeping that money idle, invest it in your regular mutual fund portfolio. If a significant emergency arises (job loss, major medical treatment, home repair), take a loan against your mutual fund holdings.

This way:

• Your money grows at market-linked returns during normal times
• You have a backup liquidity mechanism for genuine emergencies
• You are not giving up years of compounding by parking large sums in low-return instruments

Example

Suppose your monthly expenses are ₹80,000. Traditional advice says keep ₹4,80,000 (6 months) as an emergency fund.

Traditional approach:

• ₹4,80,000 in a savings account earning 3.5% = ~₹16,800 per year in interest

Hybrid approach:

• ₹1,60,000 (2 months) in a savings account = ~₹5,600 per year
• ₹3,20,000 invested in a balanced mutual fund earning 10% = ~₹32,000 per year
• Total earnings: ~₹37,600 per year

The hybrid approach earns roughly ₹20,000 more per year on the same money. Over 10 years with compounding, this difference grows substantially.

If you do need to borrow ₹3,20,000 for 3 months during an emergency, the interest at 10.5% would be approximately ₹8,400. Even with this occasional cost, you come out ahead.

When This Approach Does NOT Work

The loan-as-emergency-fund strategy has limitations:

1. Very early in your investment journey — If your mutual fund portfolio is small (under ₹1-2 lakh), you may not qualify for a meaningful loan. Build a traditional emergency fund first.

2. During severe market crashes — If the market is down 40-50%, your portfolio value drops significantly. The loan amount you can get is reduced (lower LTV on a lower value). This is precisely when you might also face a job loss or business downturn. A cash emergency fund does not have this correlation.

3. If you are uncomfortable with debt — Some people find borrowing stressful, even when it is rational. If the thought of owing money during a crisis adds to your stress rather than relieving it, a traditional emergency fund may be better for your mental health.

4. If your income is highly volatile — If you are not confident about repaying a loan within a few months, the interest costs add up and the approach becomes less attractive.

Key Takeaways

• A traditional emergency fund provides instant, zero-cost access but earns low returns
• Loan against mutual funds keeps your money invested but requires a few hours for access and costs interest
• A hybrid approach — small cash reserve plus LAMF as backup — can give you both safety and better returns
• The hybrid approach works best for investors with a portfolio above ₹3-5 lakh and stable income
• Always maintain at least 1-2 months of expenses in easily accessible cash, regardless of your strategy
• During severe market downturns, a cash emergency fund is more reliable than a collateral-based loan

There is no single right answer. Your emergency fund strategy should match your portfolio size, income stability, risk tolerance, and comfort level with borrowing. The important thing is to have a plan before the emergency happens.