Life is full of uncertainty, things don’t pan out according to your plans. Therefore it is necessary to have a contingency plan armouring you to deal with uncertainty. A contingency plan is often used to manage risk that may seem unlikely to happen; but if it does, would have a disruptive impact on your life.

A sudden loss of employment, as an example, can derail one’s financial status but most importantly, also leave him struggling to meet his routine expenses and other monetary commitment like a housing or personal loan till he finds another employer. A contingency plan will make sure that one does not have to bother if such a situation arises. It can help one to pay his EMIs on time, even if your cash flow stops for some time as you have anticipated this and kept funds aside.

Hence it becomes crucial to plan for the contingencies. This is why you must keep aside some funds as a contingency or emergency fund.

Contingency Planning Challenges

There are two behavioural traits that may be seen as obstacles when you start your contingency plan.

    Having only Plan A.

    Typically a plan would have considerable amount of emotional investment and not just a financial. It is quite a possibility that you might get emotionally attached to your goals and the planning behind it, so much so that one doesn’t think of an another plan or we should say the Plan B. A smart investor will always think of an alternative plan with the similar details and keeps a plan B, just in case its needed.

    It’s not Important.

    That’s what many of us think for contingency planning and wait for crisis to happen. As the probability of a contingency is low, it is never looked at as an urgent task, until it happens.

    Why You should create a Contingency Fund?.

    A contingency fund covers your routine monetary commitments in case of any financial emergency like a loss of employment, medical expense or any unfortunate situation or event that results in temporary cash crunch or financial loss.

Test Case: Ganesh requires ₹60,000 to meet his monthly financial needs:

Expense Type Monthly expense (₹)
Household expenses 20,000
Kid’s Education Expense 10,000
EMI 20,000
Parent’s Medical and others 10,000
Total monthly expenditure 60,000

It will be a clever of Ganesh if he keeps aside cash for his necessary routine expense as a contingency fund. As this is kept for an emergency, he needs to invest it in a option which is highly liquid. Now the question is how much money Ganesh should keep aside as a contingency fund? Ideally it should be atleast 6 months of his routine expenses. This can be extended to a year to be on the safer side.

Calculating one’s Contingency Fund requirement

In the above example, Ganesh needs to save and keep atleast ₹3.6 lakh (₹60,000 X 6 months) in his contingency fund to make sure that he can fulfil his monetary commitment for the next 6 months, if needed.

Ganesh should set aside ₹ 30,000 every month for a period of one year to build his contingency fund. Also, rather than letting this money parked in a savings bank account, he can opt for a flexi-deposit or a liquid mutual fund. Liquid funds have no entry or exit load and also provide higher returns than bank deposits.

The fact that you have a created contingency fund will surely give you the confidence of keeping your other investments and financial planning on track, even if your regular cash flow stops or lowers temporarily.

 

 

Monthly routine expenses ₹60,000
₹60,000 x 6 months ₹300,000
₹360,000 / 12 ₹30,000

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