contingency parking

Importance of Contingency Funds

An unexpected event, like an illness or a business loss could affect the financial security of your family. Such an event would make it difficult to meet your monthly expenses and/or your financial obligations. More importantly, you might break into investments meant for other goals in your life, thereby derailing your financial plan altogether.

A financial contingency plan helps you cope with such unexpected events, by keeping aside funds for this purpose.

People face some challenges in planning for contingencies

Be prepared for alternative  :  While doing financial planning, investors tend to get emotionally attached to their plans. Consequently, they tend to ignore coming up with an alternative plan for emergencies. It is essential that investors look beyond ‘Plan A’ and keep a ‘Plan B’ (or, a contingency plan) in place, for emergencies.

I dont need it (mindset) : Planning for contingencies generally takes a backseat in an investor’s life as the probability of it happening tends to be low. Many investors even hold off planning for financial crisis until it is too late. Overcoming this barrier is imperative for everyone, to avoid any unforeseen financial crisis.

How much contingency reserves one should maintain ?

As a general thumb rule 6 months worth of monthly expenses should be maintained as a contingency fund

expenses should ideally include 

Household expenses

Medical expenses

Basic travel expenses

EMI (if any)

child /parent expenses

any other regular expenses

lets understand with a small example 

Mr. X working in a software company , he is married and has  a kid , and has a car loan on his name.

his expenses are 

household expenses - 20000/-

medical expenses - 4000/-

travel expenses - 5000/-

EMI - 6000/-

child tuition fee - 2000/-

altogether comes to 37000/- , hence Mr. X should ideally keep a contingency funds worth of 37000*6=222000/-

How to build contingency funds ? 

These funds are meant for emergency situations . Hence, the primary factor to be considered while creating such a fund should be easy liquidity, so that it is available to you whenever you need it

Best investment options to park funds for emergency

Savings account

Flexible deposits with bank F.D

Liquid funds / overnight funds

You can set aside some amount of money on a monthly or quarterly basis, as per your convenience, to build a contingency fund

You should also have a ‘term insurance’ as part of your contingency plan, to protect your family financially in case of an unfortunate event. 

Contingency fund parking is very important and it is the first process before planning any investments

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