Understanding Emergency Funds

An emergency fund is a safety net that you should be able to access quickly, without hassle. By definition, you shouldn’t spend more than an hour to get this money. Two key features define an effective emergency fund:

1. Ease of Access – The money should be available almost instantly.
2. Reasonable Returns – While safety is the priority, the funds should still earn some interest.

In terms of speed, Debit Cards are the fastest, followed by Fixed Deposits (FDs). Debt-based mutual funds can also be efficient, but some are still in the T+1 category, meaning you may need to wait a day or two for withdrawals.

This “time gap” can be easily solved when combined with a Credit Card—you can spend instantly and settle the dues once your redemption is credited. Therefore, it makes sense to classify emergency funds into two buckets:

• Fast Access – FDs, Debit-linked accounts, Wallets.
• Relatively Slower (T+1) – Debt Mutual Funds, Arbitrage Funds.

Once this classification is clear, parking emergency reserves in debt mutual funds becomes an easy and rational choice.

The Problem with Debt-Based Instruments

Debt funds and FDs have one drawback – Taxation. No matter how long you hold them, the gains are taxed at your income tax slab rate.

• If you are in the 30% slab, your post-tax returns shrink considerably.
• For those in the 10% or 20% slab, this may not hurt much.

This is where Arbitrage Funds enter the picture as a smarter substitute.

Arbitrage Funds – Equity Tax, Debt-like Safety

Arbitrage Funds are classified as equity funds for taxation purposes because they invest primarily in equity instruments.

• If redeemed within 1 year → Short-Term Capital Gains (STCG) tax of 20% applies.
• If held for more than 1 year → Long-Term Capital Gains (LTCG) tax of 12.5% applies.

This makes Arbitrage Fund particularly attractive for investors in the 30%+ tax bracket, as their tax outgo reduces drastically compared to debt funds.

How Do Arbitrage Funds Work?

The core idea comes from the age-old practice of arbitrage—profiting from price differences in two markets.

Example: Buy diesel in Goa where it is cheaper and sell it in Maharashtra at a higher price to pocket the tax difference.

In financial markets, the concept is applied to equities and futures:

1. Spot Market → Buy the stock at today’s price.
2. Futures Market → Sell the same stock in the futures contract at a slightly higher price.

Since futures usually trade at a premium to spot price (due to interest rates, dividends, and market expectations), the fund locks in a risk-free spread.

This strategy:

• Eliminates market risk (since the buy and sell are simultaneous).
• Provides stable returns (usually between 5%–6.5% annually).
• Enjoys equity taxation benefits.

Why Arbitrage Fund Is Safe

Arbitrage Funds are often misunderstood as risky because they deal in equities. However, unlike typical equity funds, they do not speculate on market movements.

They buy and sell simultaneously, capturing the price difference without exposure to volatility. This makes them:

• Low-risk like debt funds
• Tax-efficient like equity funds

When Should You Use Arbitrage Fund for Emergency Money?

Arbitrage funds are ideal if:

• You are in the 30%+ tax bracket
• You don’t need instant liquidity (T+1 settlement works for you)
• You want better post-tax returns than short-term debt funds or FDs

For investors in lower tax brackets, short-term debt funds or FDs may still make more sense.

Final Thoughts on Arbitrage Fund

For investors in higher tax brackets, Arbitrage Funds are an excellent substitute for debt funds—combining safety, stability, and tax efficiency. When used smartly as part of your emergency fund strategy, they can significantly improve your post-tax returns without compromising on safety.

The post Arbitrage Fund vs Debt Fund: Smart Emergency Planning appeared first on Fleek Finance.

When people talk about diversification, normally it is from returns perspective. But, at the core of it is managing risk. We diversify because we want to make sure that price fluctuation in individual asset should not impact the overall portfolio. A perfectly diversified portfolio is one where we have inversely correlated assets, i.e. price of one asset grows if other falls and vice versa and on an average level in long term, we manage to generate good return at portfolio level, while managing the risk.

Portfolio Basics and the Need for Diversification

The concept of diversification applies even at single asset class category level too, like Equity. So, if you want to buy some stocks like a Fund Manager, there is a portfolio of stocks which needs to be constructed to ensure that the Equity portfolio is well diversified and we are able to get benefit of different businesses while also mitigating business risk. We will discuss Equity portfolio sometime else. For now, we focus on a wider portfolio consisting of different asset classes.

As you know, there are various asset classes. Typically, investors classify an asset based on its risk category. Risk is directly proportional to returns and hence the returns generated from the asset also depends on amount of risk.

There are different views on definition of risk. For the sake of simplicity, we will define volatility as risk. For example, if an asset price changes by 5-10% every day, it may be called risky because potentially one may make losses in such an asset. If another asset grows at a consistent pace and never falls, it is the least risk or zero risk because potentially there is never a loss. The risk of volatility can also be associated with liquidity or mismatch of demand/supply. When there is huge demand and not enough supply, you would see an asset price rise exponentially. Like, we see in bitcoin for example. Due to volatility, one may call it risky.

To summarize, we want to diversify to have risk adjusted returns which makes the entire portfolio grow consistently while managing risk at individual asset level.

Asset classes and the Risks associated

Lets look at different assets classified broadly based on risk for a diversified portfolio. The risk itself may be caused due to liquidity, credit default, market, business, macros and many other factors.

1. Fixed Rate Assets:

These are fixed income assets where the price appreciation is pre-decided. For example, Bank FDs, Government Bonds, Liquid funds etc. The important thing to understand here is Interest rate. You can understand Interest rate as the fixed price you get for sacrificing your present cash in hand. Money used today is always costlier than used tomorrow. If one wants to borrow it from me, I would demand an interest because I am sacrificing my present. Investors rent money today to gain interest for tomorrow.

Banks give away money as a loan to business as debt and in return, earn interest. As an investor, we deposit money in bank to earn interest. This is normally at a fixed rate based on the dynamics of a country and the central bank. Broadly, the rate is determined by inflation. That explains, why interest rates differ from one country to another.

This is an asset class with almost zero risk. I use the word ‘almost’ because there is always a risk of default in this class. We take sovereign guarantee as a word from God and believe, it will never default. But, we have seen banks default in the past and it can always happen. So, there is a minor risk which you take and that gets added to your return. Banks borrow money from RBI at certain rate and make profit on it. They also borrow from investors and pay them 1-2% higher return. This takes into account inflation and default risk. In Indian context, this returns range from 7-11% depending on the default risk involved.

If you lend it to some unsecured category individual, as some apps like Cred allow, you may get a little higher return. Some Corporate Funds may give you 11-12% return because of the extra risk taken.
Always remember, returns never come without risk. So, if you are getting 1-2% higher, remember the risk you are taking. Never buy the story of risk free return in a fixed income product unless it is a Bank FD or Government bonds. As the famous quote goes, ”In God we trust. All others must bring data.”

2. Gold

This is India’s favorite asset class. Everyone loves the yellow metal and tell stories of high returns it has given. Gold is an asset equivalent to Dollar and you can call it a global currency. Of course, there is a price change due to demand/supply. Normally, this is used by all central Governments to increase foreign reserve and there is always demand/supply mismatch for fixed amount of gold available on earth. Whenever there is a mismatch in demand/supply and there is depreciation of buying power of some currency, the gold price will appreciate. In Indian context, whenever you will see depreciation in value of rupee v/s dollar, gold prices will appreciate. Globally Gold price will appreciate depending on global demand and supply.

Based on the data available by Forbes India for past 25 years, Gold has grown at 11-12% per annum in rupee terms and has been a consistent compounder, helping individuals beat inflation largely and achieve returns better than Fixed income category. There is no liquidity risk in Gold as such since there is enough buying and selling options available. An investor can buy Gold in Physical or digital form via Mutual Funds. Government of India has discontinued fresh selling of Sovereign Gold bond. SGB was a good wealth creator for many in recent years because of it being a combination of asset price appreciation and also regular income. Some amount of Gold in your portfolio is good to keep it shining.

3. Real Estate

Land is another asset available to the world in limited quantity. The price appreciation here depends on demand supply and it is always a local phenomenon. For example, price appreciation in Pune may not be same as Indore, purely in percentage terms. Broadly, this also fits into 10-12% returns to an investor in very long term after taking different expenses into account. The real estate returns are tied to liquidity risk. The biggest risk for an investor is not being able to sell when you want. So, many would classify this as a ‘Use Asset’ for people and not really an investment because you simply buy a house and live there, effectively saving on the growing rental cost.

An individual should consider this as an asset in the diversified portfolio, purely from housing point of view. Getting return etc. will need solid knowledge of property and hence risky. Normal investors should stay away from investing in Real estate as commodity unless there is sufficient knowledge and liquid cash available.

4. Stocks or Equity for a Diversified Portfolio

A misunderstood Asset Class

Equity is a popular asset class with investors. The fact that you can check prices real time makes it an emotionally taxing asset. It requires some amount of financial literacy to make sense of value and price of underlying Assets. Financial world has always kept this as an enigma and the knowledge isn’t much democratized in this space.

Mostly investors just view it from the lens of prices. Business value is always volatile and hence considered risky. An individual should never consider owning stocks directly if they do not understand or do not have the bandwidth to understand.

Fundamentally, one must understand that the underlying asset in a stock price is a Corporate body. So, if you do not know the details of the business, you are taking a risk just based on price and it is not much different from betting in a casino. There are good fund Managers running Mutual Funds to help you own the stocks. An investor with limited bandwidth to understand business must go via Mutual funds and participate in wealth creation journey. This asset class fundamentally can generate much higher return than any other asset because of disproportionate risk involved in the assets.

Business risk and the risk Premium

The biggest risk in Equity is of business. Businesses do go bust, you know. So, the stock prices may come down to zero in such a case. As an investor, if I am taking that kind of risk, the returns expectation also should be higher. So, there is no reason for us to settle at low 10-12% range of returns in long term.

Most of the wealth creation around us is via business only. Either you create a business or own a business created by someone else. The success or failure of the business will depend on macro factors like state of economy, interest rates etc. But, the rewards are always going to be high. Several good Fund Managers have generated 15-20% and higher returns in long term. The key to success here is to think like a business owner and stay invested for a very long time.

Balancing Stocks, Bonds, and Other Assets – How to get a Diversified Portfolio

Now, that we understand the need for diversified portfolio, various asset classes available, lets understand how to diversify.

Debt Funds for Emergency Funds

A smart investor would keep fixed rate investment for emergency funds. Rest of the asset classes if you notice have liquidity risk, i.e. you may not find a buyer when you are in need of money immediately. This is where fixed rate investments are useful if they come with liquidity. PPF/EPF are not liquid assets due to long term lock-in. For emergency funds, one can consider Liquid Funds/FDs/Savings account. Typically, one should have at least 6 months of expense set aside as emergency fund. You may look for Debt-based Mutual Funds/Bank/Post Office or any other mechanism to park your money safely to withdraw on demand.

Liquid funds are not investment. They are just your risk mitigation plan. Do not look at generating high returns there at the cost of locking them up. Anything in the range of 6-8% is good enough. The main purpose here is not to grow money, but to mitigate risk of emergency.

PPF and Government Bonds

Once we have sufficient Emergency Funds, should you own PPF/Government bonds etc.? Once we have sufficient Emergency Funds, we can park money to generate higher risk-adjusted returns. Depending on your risk profile and understanding of asset, one should take risk. Remember, returns are proportionate to risk. So, no risk would also mean no return and hence inability to beat the inflation.

Debt Funds to Manage Risk

Asset allocation is never a straight approach and has diverse views. Broadly for <35 Age category, any money not needed in next 2 years can be exposed to higher risk to generate better returns. For older individuals, nature of job, dependents, short or mid-term goals will decide the risk profile. Allocate funds for near and mid-term goals. But, broadly an investor should look at generating highest possible risk-adjusted returns out of the funds available after we have taken care of Emergency needs and short to mid-term goals.

There is no rule of thumb here and one must get a risk profiling done to understand the level of diversification needed. Sometimes, there are short or medium term goals which need a different asset class. There are many who would suggest Balanced fund or 30:70 ratio for debt to equity ratio. But, it all depends on your risk profile and goal. A Financial Adviser can analyze your financial position in order to create a balanced portfolio of assets.

Adjusting Portfolio Based on Goals

A portfolio needs periodic review depending on market conditions. You will need to adjust the portfolio based on change in immediate goals or change in market conditions. For example, there are years when Equity may not give the expected level of return and optimizing the portfolio by switching some funds to debt or Gold may generate better returns. Multi-Asset Mutual Funds take care of this balancing and is good for peaceful investing technique. Alternatively, an individual can do this exercise. It is not easy to time the markets though and it needs expertise. So, it is advisable to go via Mutual Funds.

Final Thoughts on Diversified Portfolio

A diversified portfolio is key to peaceful investing. An ideal portfolio is where you don’t lose a night’s sleep. Money management should come with peace. Diversification is also a way to achieve peace because it ensures stability irrespective of market conditions. Look at different asset classes and based on your risk profile, allocate sufficient funds in each category. The portfolio needs adjustment based on goals. A Financial Adviser can guide you through the process. It is perfectly fine to manage it on your own if you are equipped with right knowledge. In this internet age, overflow of knowledge can make you confused and you end up making wrong decisions. Hence, consulting an financial expert is always good to ensure you are making a right choice.

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