Going to the basics of contingency planning, it is recommended having a fund equal to six months of ‘critical expenses’. So in order to arrive at an appropriate amount of contingency fund for your self, you have to understand the concept of critical expenses which are those expenses which have to be incurred irrespective of the earnings. There is no ready made formula for arriving at the critical expenses but the following expenses are to be taken entirely as critical expenses while doing contingency planning:
* Food and Grocery
* Salaries of helping staff at home
* Children school fee and conveyance
* Insurance premiums
* EMIs of any type
* Medical expenses
Life insurance premiums can be of different nature. A term or health insurance premium is very-very critical since non payment means policy lapses with immediate effect (beyond grace period of 0-30 days). In case you have a ULIP, and already three year’s premium has been paid, it is usually possible to take a break thereafter. In case of a traditional endowment plan too it is possible to take a break after 3 yearly premiums although the risk cover in most of them is reduced to some extent and the premiums can be resumed within six months of due date. Beyond that the policy is treated as lapsed and has to be revived, which might require fresh medical tests and other formalities.
There are certain expenses which can be a mix of casual and critical, which are:
* Cable TV
* SIP payments
And then there will be expenses which are truly casual:
Multiply the monthly critical expenses by six and you arrive at emergency cash needed by you. This multiplier of 6 can be less if there are other sources of income like an earning spouse or some income from a fixed investment like FD or some agricultural income, rental income or HUF income which can also reduce the emergency cash needed.
Once the contingency fund is accumulated, keeping it in a saving bank account which yields around 2-3% per annum is not desirable. A better option is to go for an auto sweep account wherein any money beyond a fixed level is automatically converted into an FD and the rate of interest is definitely better. Having an ATM card is possible in both the above bank accounts and that gives ready access to cash, 24x7, although with an upper limit on withdrawal per day. Auto sweep facility is now being offered by almost all banks including a number of PSU banks.
Another way of retaining a contingency fund is to go for a debt mutual fund schemes of short term nature which is better in the sense that accrual of returns is on a daily basis unlike FDs and auto sweep accounts. Debit card facility is also available in a few mutual funds wherein money can be withdrawn from the ATMs of a designated bank, again with an upper limit per day. The returns can also be improved slightly by having a small equity exposure although it entails some risk which can be minimised by the financial planer. Investing in mutual funds, especially for parking contingency fund can involve certain technicalities since there are different types of debt funds available in the market. It is therefore advisable that you consult a trained financial planner for the same as well as for overall financial planning.
The author is a Certified Financial Planner and Regional Head, Wealth Gyan Financial Planners Pvt. Ltd, Chandigarh, views expressed here are those of the Author alone and not of FPSB India