In today’s times, a contingency fund of at least six months is good to have as security in case of any kind of emergency.
Emergencies never come announced, least of all the financial burden associated with it. While debt is an option that may easily come to mind when in need of emergency funds, it’s wise to be prepared for such days with a contingency fund. There is no set standard on how much a contingency fund should comprise of, as it depends on an individual’s income, expenses, debt and their disposable income. However, in today’s times, a contingency fund of at least six months is good to have as security in case of any kind of emergency.
Let’s see how you can start planning for that much-needed contingency fund.
1. Calculate Your Expenses and Investments
To assess how much you will need for at least 6 months, you need to work out your monthly regular expenses like rent, food, transport, children tuition fees, groceries and more. You also need to factor in monthly EMIs for house, car or any other loan, along with average credit card bills.
Apart from monthly spends, chalk out a 6-month calendar to see when your investment payments like medical and life insurance, SIPs for mutual funds, PPF account contribution and more are due. You will need to keep that money separately so as to not fall short on your monthly expenses. If you are family comprising of husband and wife, both of whom are earning, make sure the calculation is done for the family as a whole.
The figure that you will arrive at will reflect how much you need to save to build a contingency for 6 months. It will not happen all at once, so you may have to set a timeline by which you can practically achieve your target.
2. Identify Areas to Cut Corners
After assessing how much you need to last for 6 months, you need to start re-managing your expenses and identify spends that can be reduced or totally done away with. It may be reducing your credit card bills, dining less frequently outside or letting go off some luxuries while vacationing. In whatever way possible, try cutting at least 10 to 15% of your current expenses to accommodate the same for investing in your contingency fund.
3. Assess Final Disposable Income
Your final disposable income after your expenses are accounted for and your strategy to cut costs is taken into consideration, will determine how much time you need to build the corpus. For instance, if your monthly expenses including EMI’s and investments as a couple are Rs 1 lakh, you should aim for nothing less than Rs 6 lakh as your contingency fund. In order to achieve this, you have to see how much can you spare from your disposable income at the end of every month. If combined you can spare a sum of Rs 25,000. It will take you 24 months to fulfill the fund target, not factoring in any additional interest earned.
It’s important not to stop unless it is an emergency. You can also pull out lump sum money from existing deposits if you think you will not be needing them soon and also include any investment payouts that mature during this time. Once you have reached your contingency goal target, you can re-work your investments accordingly.
4. Divide Your Investments
Ideally contingency fund should be kept in traditional liquid options like a recurring deposit or non-5-year fixed deposit, which can be broken when required. But in case you are looking for more options, try liquid funds as they are best suited for this purpose. They do not carry an exit load if sold in less than a year’s time and can be redeemed immediately.
You can also open a joint savings account with your spouse or parents and contribute equally every month to build the corpus required. It is advisable to divide your investments or savings into more than one fund so that you only take out what’s needed and let the rest stay.
5. Things To Take Care of
# Make sure medical insurance has enough coverage for the entire family, so you do not have to dip into your contingency fund in times of an emergency.
# Get a term plan for the main breadwinner of the family or both in case husband and wife have similar income.
# If you have children, it may be wise to invest in a child plan that could take care of your child’s higher education when the time comes.
# Avoid taking any new loans until you have repaid existing ones.
# You may wish to replenish your contingency fund if you choose to take out funds when needed.
(The writer is CEO at Bankbazaar.com)