A Contingency fund is not an option
We know from old grandmother tales and Hindi movies how the lady of the house would store money saved in the rice drum. She would reach out to it when there is crisis or when there are emergencies like a sudden medical expense or a loss of job of the primary bread earner.
A contingency fund or an emergency fund is a fixed amount that you need to keep aside to take care of an unforeseen and urgent situation. It is an amount that you specifically earmark for this purpose, and do not use for any other need. This amount is strictly meant for emergencies, nothing else. The rationale behind having a contingency fund is the fact that even if there is loss of income or a sudden unexpected expense the person should be able to maintain the same lifestyle for a given period of time without compromising on funds saved for long term goals.
Events like an uncovered medical emergency in the family, salary cuts or job loss, changes on the personal front like a death of an earning family member, divorce and subsequent financial complications etc. can derail an individual’s financial goals and plans.
The last thing you would want to worry about at such a time is money and hence it is best to be prepared. A fund earmarked as an emergency or contingency fund would not only provide financial stability during such a time, it would also provide you tremendous peace of mind so that you can focus fully on the problem at hand.
Since an contingency fund needs to be liquid and available at hand , you could consider parking these monies in either your savings bank account, a flexi fixed deposit or a liquid scheme of a mutual fund. Highest returns are not the most important criteria while making your decision. Rather liquidity is, so that the money is available to you at short notice.
How much should you save for an emergency fund? Well, it really depends on your comfort level. It’s the money that would make you feel safe and provide you peace of mind during times of trouble, so only you can decide how much is enough for you. It had being said that, the general consensus is that a contingency fund should be 6 months expenses including EMIs and insurance payments. If you are more conservative you could choose to save more too. However too much of a contingency fund can dampen overall returns from your portfolio as the investments are in low yield liquid investments.
Review your fund every year as your expenses and cash outgoes will also change and hence adjustments to the amount set aside are imperative.
Investment in long term goals can start only after building a contingency fund. You may either start with monthly savings or in one go, if you have got lumpsum money.