Everyone wants to have a peaceful and stress-free life. No one wants to face financial duress if they're not prepared, right? But the future is uncertain, and nobody knows what’s going to happen the very next moment. And if any unfortunate event occurs, e.g., an unexpected job loss, it poses a risk of severe financial repercussions. These all are beyond our control. Luckily, there's something one can do to prepare for life’s uncertainties, build a Contingency Fund.

In this blog post, we will discuss what Contingency Fund is all about, its importance, and how you can build one for yourself.

What is Contingency Fund?

A Contingency Fund is a corpus set aside to provide a financial safety net for unplanned expenses or life's unexpected events. It acts as a financial buffer that can keep you afloat in a time of need without having to rely on somebody else's help.

It is also known as a 'Rainy-day Fund' and an 'Emergency Fund' or 'Emergency Corpus', and it really does come in handy when the going gets tough!

Why should I have Contingency Fund?

Have you ever met a situation where the cost of damage caused by an accident exceeded your insurance coverage? or maybe you had to undergo an expensive medical treatment that wasn't covered by your insurance? Any such event can drain the savings of years. All of these are situations in which having some extra cash on hand would have made a big difference.

Everyone would have felt the need for an Emergency Fund at some point in their lives. Having a small nest egg set aside for a rainy-day can help you avoid any severe financial repercussions and prepare for the unexpected. It creates a breathing room wherein if someone loses his/her job or there is big cut in salary or there is loss of business, they have an Emergency Corpus that takes care of the expenses like utility bills, food, EMI, and other expenses for the time being.

Well, we all face unexpected situations in our life. Contingency Fund proves useful in such situations since:

• Emergency Corpus helps to cope with unplanned expenses; thus, you have adequate time to make decisions and find ways out of it, without having to panic.
• It prevents you from taking out high-interest loans or borrowing from family and friends, thus saving you from spiraling into debt.
• Creates a habit of saving money, which encourages you to learn financial discipline.
• Through Contingency Corpus, you are protected from unforeseen circumstances and can navigate rough times with confidence.

We need this safety net because no matter how meticulous we are with our budgeting, the unplanned always seems to happen when we least expect it.

How much corpus should I set aside for Contingency Fund?

An optimal amount of funds you need in your savings varies based on several factors, such as your cost of living, family size, and age of family members.

A simple rule of thumb for Contingency Fund is 6 to 9 months of your household expenses or simply, 6 to 9 full salaries. If you can afford to put aside more than that, even better! It would be prudent to have 6 to 9 months' worth of living expenses saved up as a Contingency Fund so that even if something happens where you lose all your income temporarily, there will still be funds available for anything else life throws at you! More specifically, it covers up expenditures, such as rent/EMI payments, groceries, utilities, transportation, etc.

How to build Contingency Fund for myself?

The thought of setting aside a few lakhs may seem overwhelming, but it’s not impossible. With proper planning, financial prudence you can easily achieve it. If you know that in your head a "perfect" Contingency Fund is something you want to have but don't know where to start, then it's time to get down to business! Here are some simple rules that will help you build your Contingency Fund:

• Set a Goal: Setting a goal date for achieving the emergency fund could help you reach it more quickly. Depending on your financial situation, you might set the date as 3 months, 6 months or even a year.
• Make a monthly commitment: It is easy to accumulate the targeted corpus if you divide it into monthly commitments. Determine your shortfall figure, which is the excess of your requirement over your available funds and assign a monthly amount to the fund.
• Create a System: Automate your savings so that a certain amount is transferred out of your savings account to your Contingency Fund each month. This way, you're not even tempted to spend it.
• Regular Monitoring: Keep track of your progress regularly. Maintaining track of your progress will encourage you to continue.

When deciding how much money should go into the Contingency Fund each month, there are three main factors to be considered: 1) Monthly Income, 2) Monthly Household Expenses, and 3) Investment for Future Goals.

Where should I park my Contingency Fund?

In emergencies, there is nothing better than liquid cash, but it may not be the perfect avenue given the safety concerns and the zero return on the available capital.

A Contingency Fund is a corpus that you set aside specifically for unforeseen or unfortunate events. Therefore, while deciding where to invest this fund two prime criteria should be Instant Liquidity and Low Risk. Savings account, Fixed Deposits (FD), and Low-risk Mutual Funds (e.g., Liquid funds) are some of the options preferred over volatile investments such as Stocks and Equity Mutual Funds.

If you require immediate cash withdrawal, then a savings account is the only place to park your fund. An FD is a good option if you're planning to save the fund for long-term needs with stable returns. But bank FD has its own disadvantages, like Minimum investment amount, Fixed maturity period, and Penalty on early withdrawal (Tax Deducted ta Source).

Liquid Funds turn out to be a better alternative to FDs. Liquid Funds have few advantages over bank FDs, such as:

• you can get started with very small amount, unlike bank FDs which requires minimum investment of ₹ 10,000.
• Liquid Funds tend to offer higher returns than bank FDs
• No Lock-in Period
• No penalty on early withdrawal [However, a negligible exit load is charged (0.0045% – 0.0070%) if fund is redeemed within 7 days.]

Based on your specific needs, the answer to where to park your Emergency Corpus may vary. Following are some considerations to take while deciding where to park the Contingency Fund:

• Instant liquidity, which means how quickly you can get your money.
• Risks associated with the investment, if any.
• Returns on investment
• Maturity or Lock-in Period
• Ease of investing and withdrawal

Do's and Don'ts

Do's

• Do keep in mind that the contingency fund amount should be realistic, neither too small nor too big.
• Set separate savings goals for short-term and long-term emergencies.
• Make sure you are keeping the corpus in a separate savings account.
• Park your funds in instruments that yield decent returns with low risk and provide instant liquidity.
• Automate your monthly contribution towards your contingency savings.
• Do have a plan for how you will replenish the fund once it's been fully used up.

Don'ts

• Don't wait some emergency to occur to set up your Contingency Fund.
• Don't keep all your Emergency Corpus at one place.
• Don't withdraw from your Contingency Fund unless you really need it.
• Don't think of Contingency Fund as a means of storing extra money for future purchases.
• Don't squander your Emergency Corpus on a frivolous purchase like a holiday, new car, expensive gadgets, etc.
• Don't hesitate to ask for help. If you're confused about how to set up a contingency fund or just need some additional guidance, just contact Wealthstreet's financial advisor and they'll be happy to help!

Conclusion

Knowing how to handle emergency situations is crucial. Without Contingency Fund, you may face serious financial difficulties in the event of an emergency. Also, it is important for your peace of mind. We hope this blog post has helped you learn more about Contingency Fund. If you have any questions or concerns regarding Contingency Fund or any other financial matter, please feel free to contact us.