Contingency fund: Your first step towards financial wellbeing!

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.

Author

Sana Shaikh
Volunteer – Wealth Management
M. Sc. Finance
NMIMS, Mumbai
Batch of 2020-22
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Find out how much return your investment should give to retire at your desired age in just 2 mins

The other day I received an SMS saying invest Rs. 5,000 every month till the age of 60 and get Rs. 30,00,000 lump sum and Rs. 25,000 every month post the age of 60. I am sure every one of us is bombarded with these kinds of messages every other day. There are several online calculators available to check how much you should invest now to get the desired amount at the age of retirement. But what if you don’t have that much amount to invest in? Also, do you know much return your current investment should earn to generate a corpus for your retirement?  To be honest, I didn’t know so I guess we are sailing on the same boat.

So without wasting any time, let’s see how can you use our tool to know the Return on Investment (RoI) required on your current investment to generate a corpus for your retirement in just 3 steps. Download the sheet from here.

What are the objectives of this sheet? 

The whole purpose to build this sheet is to tell you how much return your investment should earn so that you can generate the desired corpus for your retirement. 

What are the questions will be answered by this sheet?

You will know how much RoI needs to be earned on your investment. You will also know the amount you require to retire with. It also calculates your per annum post-retirement expense.

For illustration purposes let us assume there’s someone called Mr. X. He is 25 years old. He wants to retire at the age of 60 and expects to live till the age of 85. His current salary is Rs. 95,000 per month.

Follow the below steps to get your questions answered:

Step 1: Enter your personal details

Here, you are required to enter your current age, age at which you want to retire and age till which you are expected to be alive. Please note, this sheet is designed for a person who is more than or equal to 25 years old and expected to live till the age of 99.

Step 2: Enter your per month income and expense

In this step, you are required to enter your current per month salary. Expected every year increment in salary and bifurcation of a monthly expense. Please note: It is required that saving as a percentage of income to be more than or equal to 15% (Otherwise person either has to increase his salary or reduce his expense)

Step 3: The easiest step among all

One only has to press submit the inputs enter by one.

The output of the sheet:

The Output indicates how much person has invested till retirement and what RoI he should target on his investment. If a person manages to get the RoI calculated by this sheet, he can achieve his corpus by the time he retires. ( Basically, in this case, Mr. X has invested Rs. 1.44 Cr. till 60 years and he has managed to get RoI of 12.44% on his investment. So at the age of 60, he has generated a corpus of Rs. 20.26 Cr. which will take care of his post-retirement expense.)

This graph indicates how generated corpus will be depleted over a period of time
This graph indicates the proportion you have invested and corpus generated by your investment with RoI calculated by the sheet

So those who are interested to know the math behind this, here we go!

Following are the few assumptions made by me while preparing the sheet. Please refer the same.

Let’s look at the Expense tab:

Expense sheet indicates how your expense will grow over a period of time. To be on the safer side I have considered 13 months as annum. I have also considered growth rates of each expense heads will remain the same for a decade and will be revised by 0.5% compounded annually (Can be edited as per your requirement). 

Salary and investment tab:

We know our annual salary and annual expense. Annual saving is just a difference between income and expense. I have kept 5% (editable input) aside as an emergency fund which will be kept aside in savings account. Available per month funds to invest is remaining funds in hand after the emergency fund is kept aside. Now, Corpus generated is a sum of funds in hand and money parked in a savings account. (Note: Funds in hand should fetch min. RoI as shown in the output box)

Corpus tab:

Corpus sheet indicates post-retirement annual expense and how that corpus will be depleted over a period of time to cover your expense. Here I have considered the generated corpus will fetch 3% post-tax return on the corpus (Pre TAX savings return is 4% -editable input).

Hope this article has helped you to understand your target RoI on current investment and required corpus to retire on desire age. Let me know topics you would like me to cover in next post in the comment section below.

Author
Kartik Tripathi
Forerunner- Finvert
(M.Sc. Finance, NMIMS – Mumbai 2018-20)

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