Is life predictable? Of course, it is not. So what do we do, if something is unpredictable? We remain prepared for any situation, isn’t it? Same is the case with the unpredictable financial situation. Read on to know how to deal with such an unpredictable financial situation.
In my first article, we saw a simple yet easy to implement the concept of personal finance, the ‘50/30/20 rule of budgeting’. In this article, I bring you one more such concept, the ‘Contingency Fund’ which is often one of the most ignored concepts yet highly essential. Below is the ‘Pyramid of Investment Needs’, which depicts our financial needs and the order in which these should be achieved. And contingency fund is the foundation block of this pyramid.
The contingency fund is a certain amount of handy fund to be kept ready for dealing with unpredictable difficult financial situations. It gives you the required cushion to deal with situations like sudden job loss, sudden medical expenses, etc.
Now, what should be the amount of contingency fund you should keep handy?
Contingency fund is best described by expense ratio, which is as below:
Expense Ratio= (Amount in your savings account + Cash with you + FDs + value of your liquid funds) / Monthly expenses.
This ratio, as a thumb rule, should be 6 for salaried people and 12 for professionals and business people. The ratio is higher for professionals and business people as their income is irregular.
For example, if you are a salaried person and your monthly expenses are Rs. 50,000, you should keep Rs. 3 lacs into easily accessible avenues like fixed deposits, cash, in savings accounts and liquid funds, so that your contingency funds can support you for at least 6 months meanwhile you put your income stream back in place. Other investments avenues like, equity mutual funds, debt mutual funds, stocks, etc. should be kept out of the purview of the expense ratio, as all these investments would take little more time to be encashed and be available. Cash and amount in savings accounts are immediately available, FDs can be encashed on any working day of a bank and if you redeem your liquid funds before 3 pm on a working day, the amount is transferred on the next working day to you savings account.
Hope you take this article seriously and keep a contingency fund always ready.
See you in another such article. Un till then Happy Investing!
To know about liquid funds watch our video:
If want to know about ‘Hierarchy of Investment Needs’ watche our video: