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Contingency fund – A good to plan a in fluid times

WE ARE all aware of the term personal financial planning as we have heard about it either on television, read in newspapers or had our advisers use it before us.


Earlier, we could afford to ignore it as “earning returns” was not that complicated. But in the prevailing times, when economies world over are struggling to overcome recession, boost demand and accelerate growth, financial planning gains much prominence. It is more a need and necessity than being a matter of choice.

While financial plans differ from individual to individual and situation to situation, one recommendation that is uniformly maintained is the need for maintaining an emergency fund, a contingency reserve that can come in handy if situation demands. It was a common trend to find most people take this part of the plan lightly and not abide by this recommendation, thinking that they could always swipe their debit/credit cards and access liquidity as and when required.

But times have changed. There is an increased level of uncertainty about almost everything. One can’t be sure of the next day in office or how well one’s business would fare. Liquidity has dried up and despite the stimulus packages and relief measures being announced world over, we are nowhere near the perfect safe world that we were a part of just a year back.

For every earning individual, it is highly essential that he/she maintains a contingency fund at all times. As a thumb rule, it is suggested that the contingency fund be equivalent to at least two-three times of an individual’s monthly household expenses but it is best to follow professional advice to determine the exact fund size.

In times like these, when the economic disturbances are widespread, it is best to increase the size of the reserve fund too. The appropriate fund size would vary for an individual who has multiple EMIs running or who has some other obligation due in short to medium term. For people employed in sectors driven by global demand/ linked to share markets, it makes sense to build their fund size month on month.

So, how does one go about this exercise of planning for a fund reserve? Firstly, try to measure and manage your inflows and outflows effectively. If you have your outflows mostly apportioned for committed payments that you can’t do much about, try and cut on the miscellaneous bit and allocate the same towards your contingency fund. On the other hand, if your cash flows are comfortably placed with minimal obligations, still it would be wise to allocate a part of the monthly package towards maintaining the contingency fund.

Secondly, try and incorporate cash as an asset class in your overall portfolio placement. So, if you have your daughter’s higher education goal for which you have allocated 60% equity and 40% debt, then try and modify the overall asset allocation by introducing cash as a part of it. You can follow an allocation with 55% equity, 35% debt and 10% cash. This cash element shall add further weight to your fund reserve and provide you with the much-needed assurance and mental peace. Expert help to modify the asset allocation in light of current situation is warranted.

Just to create an emergency fund, one cannot and should not mess up with the overall cash flow situation. A step by step approach is the best way to create, maintain and manage a fund like this. So, if you are one of those who never gave a thought to maintaining a contingency fund, there is no need to panic. This is the time when wise and well-planned action can help you sort the case. Start with the minimal amount that can be comfortably adjusted in your situation and then periodically increase the contribution to the fund until you reach the ideal size.

It is also important to know that various investment options are available in which one can maintain a contingency fund. You can either hold cash in hand or in a savings bank account or you can also consider investing in liquid and liquid plus funds offered by different mutual funds. As you build on a reserve equivalent to two-three months expenses, the balance amount allocated to the cash fund can be also be invested in short term debt funds/ gilt funds with a view to earn better returns across the specified term.

It is best to view your financial life as a whole rather than follow a piece meal approach. If the current times can help us learn from our past mistakes and reinforce in us a strong well-defined approach towards managing our hard earned money, then why shy away from it.

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