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Tips to preparing a contingency fund
Joydeep Ghosh | May 14, 2007
When Kavita Mishra, a software engineer decided to take a break and join a NGO, she was at peace with herself. "I have enough to last me for at least six months," she claimed to her friend. But within three months, she was back in the job market and in desperation.
"I am running out of money too quickly," she confessed. Obviously, her friend was confused that how could someone who had six months savings be almost be broke in half that time.
But a detailed conversation revealed some interesting facts. While creating her safety net, Kavita had only considered her home loan monthly instalments and household expenses while conveniently ignoring her other commitments like mediclaim, life insurance and investment plans.
Once those payments had to be made, her budget started going berserk. Says Sajag Sanghvi, a certified financial planner, "Your safety net saving should be your entire present salary and not some fraction of it." In other words, instead of looking at your monthly expenses, use your monthly earnings as a benchmark while preparing a safety net kitty or contingency fund, as it is better known.
Of course, the size of the corpus could differ, depending on your age and number of dependants. Explains Kartik Jhaveri, director, Transcend India, "Ideally, a young person with little responsibility should have savings of around one or two months of his/her income." This increases to between three-six months, if one is married and is the only earning person. For a double income family, two-three months would be ideal.
And, while preparing this kitty, one often forgets to include payments, which happen infrequently. But it is necessary to remember these periodic payments, as they form the backbone of your overall financial planning. So include expenses on life insurance, medical insurance and other compulsory savings goals like children's education or other investments.
So how should one go about creating a safety net for oneself? "If starting now, one should put 25 per cent of one's salary into this kitty," says Amar Pandit, director, My Financial Advisor. That is, if you start your career with a salary of Rs 20,000 per month, keep aside Rs 5,000 a month into an account, which should not be used by you often.
The basic idea is to have a savings target and meet it, before going into a spending spree. By saving Rs 5,000 per month, in a year's time you would be able to have three months' salary in your contingency fund (Rs 60,000). From there, the job gets easier.
That is, after diligently saving for one year, you have created a corpus of Rs 60,000. After that, if you get a salary hike of 20 per cent, your earnings would have gone up to Rs 24,000 per month. But to have Rs 72,000 (three months salary), now you need only Rs 12,000 more. This implies that you need to save Rs 6,000 (25 per cent of your earnings) for two more months to complete the kitty.
Now, the question is where should you park these funds? The point to remember is that you should be able to access this money at a very short notice. Obviously, that implies that you cannot invest these funds in property or equity funds. "You should have a combination of liquid funds that invest in money markets and bank fixed deposits," says Sanghvi. "You could also look at short-term fixed maturity plans," adds Pandit.
Once your safety net is in place, you can start investing aggressively in mutual funds or buy blue chip stocks. "If you have financial goals that are more than ten years away, it is ideal for you to go for mutual funds," says Pandit.
However, as you grow older and have dependants, you need to add more to your savings plan. Some additional cover such as a disability plan would be ideal. These plans ensure that you have a regular income stream in adverse times.In short, start saving and start now. In India, the salaried individuals are just beginning to enjoy the fruits of liberalisation. But we are yet to reach a stage when there is a social safety net that funds your rainy days. Bottom line: it's up to you to create your own safety net.