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15 June 2020 | 4 min read

5 Reasons To Make A Contingency Fund A Priority

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Life is unpredictable! And if we were already not aware of this fact, the pandemic has just made it resoundingly clear. The worldwide lockdown and sudden shutdown of the economy put a dent in all of our plans, be it marriage, travel, or any other commitment we made to ourselves and people close to us.

If you were lucky, you still have your job, even if you took a pay cut. For others, who were furloughed or laid off, things might look bleak at this moment. And only in such dire circumstances, the importance of having a contingency fund hits home. If you already built one for ‘rainy days’, you are a step ahead in securing your financial future. For others, better late than never, right? Read more to know the reasons why building a contingency fund should be your topmost priority right now. Of course, as soon as you can manage to stash away extra cash!

What Is A Contingency Fund?

Reason to build contingency fund

To put it in a nutshell, a contingency fund is a liquid asset {cash, mostly} which can be withdrawn immediately in unforeseen circumstances like sudden travel, medical emergency, job loss or to buy something that went on sale. Your contingency fund acts as the buffer that protects you and your finances in case of unplanned events. This also includes bailing out your friends from a financial emergency. A contingency fund lets you do all this without hampering your lifestyle and keeping your mental peace intact.

Reasons To Build A Contingency Fund

Reason to build contingency fund

Unless you have a crystal ball that predicts {to the T} your future, anything can happen. And this is precisely the top reason why you should have a contingency fund. Other more evident and rudimentary reasons are:

  • To hit pause and take a sabbatical from work. We are only humans, and there is only so much work we can do without burnout. This is where a vacation or extended break from work comes in. Having a contingency fund gives you this option.
  • To avoid unwanted credit card bills or borrowing from friends. Having a contingency fund ensures you don’t max out your credit card when things go awry. It gives you financial independence where you don’t have to rely on your friends or family to bail you out of unexpected inconveniences.
  • To pay for sudden travel overseas. The unexpected death of a relative in another country or your close friend needs assistance to recover from an unforeseen situation, and there are various reasons why you may have to travel abroad. The return fare can leave a dent in your pocket. Thus, the contingency fund comes in handy in such a situation.
  • To cover medical bills. The biggest argument put forth for this is medical insurance. Yes, we all are smart enough to invest in one. However, there are a lot of things that the fine print of your medical bills won’t cover, and the last thing you want to stress you out when you are severely ill is your medical bill.
  • To pay for large expenditures. Not just emergencies, but contingency funds are also essential to pay for significant expenses like an investment of cash in your startup idea. Or put the down payment for a home you have always wanted, and it just went on sale. A contingency fund gives you the freedom to go for those dreams of yours – from a car to a house to even starting your own business someday.

Excited to start a contingency fund – your journey begins here.

How Much Money Should You Have In Your Contingency Fund?

Save money for contingency fund

This brings us to the quintessential question of them all – the ideal amount of money you need to have in your contingency fund. Financial experts suggest having at least a minimum of three to eight months of liquid cash set aside in your contingency fund. This does include not only your rent but also your investments and other living expenses. Let’s take an example. Say, a person by the name of Karan who is currently earning INR 80,000 per month. He has a stable job, but he decides to build a contingency fund given the uncertainty of the market in the pandemic. He lives in a metropolitan city where he is paying a monthly rent of INR 20,000. His household and other expenses cumulatively come to around INR 35,000. Here is a split for your reference.

Rent – INR 20,000

Household Expenses – INR 15,000

Other expenses (EMI and Investments) – INR 20,000

Total living expenses – INR 55,000

Now, as you can see, Karan needs a minimum of INR 55,000 per month to keep him afloat without affecting his lifestyle in case he loses his job. Multiply this amount by 6 or 8, depending on the months for which Karan decides to create his contingency fund. And that is the amount he needs to save. For Karan, it amounts to INR 3,30,000 for six months.

Similarly, you can do a quick calculation for yourself. Once you have settled on the mode of saving {RD, FD or your savings account} to build your contingency fund, you need to deposit that money every month till you achieve the target. Yes, the target or the stretch goal by when your fund will be ready should also be predefined. Find out more here.

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