Financial advisors have time and again advised investors on creating a Contingency corpus. In fact, one of the basic financial lessons we have learnt from our parents is, always save for a rainy day.
Unprecedented times of global pandemic, lockdown extending to almost 6 months, business shutdown, increasing job loss, have further demonstrated the requirement of having a contingency corpus. A contingency fund provides you with some cushion to fall back on in case of an unexpected income loss.
So how does one start? The first step is to determine the value of your Contingency fund. The average rule is 6 months of fixed expenses in case of single income household or 3 months of fixed expenses in case of multiple income households. Ensure you include your rent, maintenance, grocery and food bill, the education cost in any. In case of an ongoing EMI ensure at least 6 months provisioning even with multiple income households.
Now, once you have estimated the appropriate size of your contingency corpus, how does one go about saving for it and where should you invest the money? The instruments suited for investing the contingency fund is ideally which have high liquidity and focus on capital protection. As it is not the job of a contingency fund to earn a high return. The job of a Contingency fund is to be there in an emergency and should be easily converted into cash.
Contingency fund needs to be divided into multiple components, rather than treating it as one single chunk of money. Instruments like Liquid funds, Ultra short term fund, Fixed Deposits etc. are few of the avenues one could look at investing.
It is also suggested, to keep around 10 to 15 days of your expenses in hard cash at home. Because the emergency can also come in the form of a natural catastrophe, during which banks can remain shut and several ATMs not working.
Rest of the funds can be spread across Deposits and Mutual funds. Do remember as per revised SEBI guidelines, Liquid fund have exit load up to 7 days. Also, while selecting a Liquid fund or an Ultra short term fund ensure the fund has a high quality portfolio. A large portion must be in sovereign or AAA-rated papers and is not mandated towards chasing higher returns.
Do remember to de-risk your contingency corpus, reduce bank risk by spreading out your deposit in more banks and mutual funds also by investing in at least two fund houses.
Since we all know the need for a Contingency fund, why do investors still fail to provide for it or have insufficient funds allocated? One of the major causes is most of the time the investors cannot provide for the entire fund value at one shot and eventually end up not saving enough.
One of the strategy investors should opt for is systematic saving for Contingency Corpus fund too. One can start with a SIP into a liquid fund or ultra-short term fund, many liquid funds have provision for SIP into liquid funds too. Another option is starting a recurring deposit.
Thus, it is never too late to start provisioning for your Contingency fund, you can start small and build up towards the required corpus. Also, now that you are staying at home and are practising social distancing due to COVID-19, you can use this opportunity to save the money you would normally use on things like dining out, travelling to work, vacations etc toward your contingency fund.
As our Grandmother used to say, like an ant save for the rainy day.
Volunteer – Wealth Management
M. Sc. Finance
Batch of 2020-22
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