How big should be your contingency fund?

Financial Planning | admin | November 1, 2011 at 5:26 am

What is a contingency fund?

It is money that should be kept in a liquid instrument to take care of any unforeseen and urgent need, such as a medical emergency. This amount should be specifically allocated to meet an exigency and must not be used for any other purpose. It is important that the amount is big enough to take care of the emergency.

Why do you need one?

You need an emergency fund because if your income flow stops for any reason, such as job loss, you (and your family) should be able to maintain the same lifestyle for a reasonable period of time. This is why financial planners insist that this should be your first financial goal. Other long-term goals should be considered only after this.

How much should you save for emergencies?

It is important to optimise the size of the contingency fund. A fund smaller than the requisite amount will defeat the purpose of setting it up. On the other hand, a fund bigger than you require will mean an opportunity loss since your money will earn a lower return than that it would rake in by investing in other avenues. In the long term, the loss on this account can be substantial.

IF YOU HAVE MAXIMUM As

Congratulations! You are well-equipped to deal with financial emergencies. You should have a contingency fund that is 1-2 times your monthly income. To meet this target in a year's time, start saving about 17% of your income. Based on the likely need for and size of your contingency fund, you can put it in short-term debt funds, which offer good returns and are also fairly liquid.

IF YOU HAVE MAXIMUM Bs

You are reasonably prepared to deal with financial emergencies. You should have a contingency fund that is 3-4 times your monthly income. To meet this target in a year's time, start saving about 34% of your income every month. You can keep the money in a sweep-in bank account. This account combines the features of a savings bank account and a fixed deposit

IF YOU HAVE MAXIMUM Cs

Sorry, you are ill-prepared to deal with financial emergencies. You should have a contingency fund that is 5-6 times your monthly income. To meet this target in a year's time, start saving about 50% of your income every month. You can keep the money in liquid schemes of mutual fund houses. Liquid funds can be quickly redeemed and the money can be in your bank within 24 hours.