Emergencies don’t come knocking on your door. That’s why most financial planners advise setting up an emergency corpus. Some even suggest a separate contingency corpus.
Contingency and emergency funds
Contingencies and emergencies are short-term expenses, though there is a very thin line between them. Emergencies such as hospitalisation come unannounced, either for us or our dependants. A contingency expense is something that is likely to happen, for which you need to set aside money, like a court case or a possible tax liability. You can also set up a contingency fund if you think you will take a break from your work sometime in future. Many financial planners suggest building just one corpus to cover your contingencies and emergencies, but some suggest separate funds.
How to build
Let’s assume you want to put everything in a single pot. Draw up your monthly expenses. A thumb rule is to have six months’ worth of expenses in this kitty. This includes not just your expenses on daily use items like groceries and petrol, but also your ongoing loan repayment instalments and systematic investment plans (SIPs). A break from work or an emergency or contingency should, ideally, not cause a break in your investment plan. You can also target an absolute figure, say, Rs3-5 lakh.
The idea behind an emergency or contingency corpus is that the principal should be as safe as possible. Returns are not important, but you can certainly earn a bit more than what your savings bank account gives. Many banks offer fixed deposits linked to your savings account where you can transfer money over and above a certain limit so that it earns a higher interest rate. You can also start an SIP in a liquid fund till you have enough in your emergency kitty.
Keep in mind
The biggest mistake is not having an emergency corpus at all. You may have a health insurance policy, life insurance and other insurance covers too, but remember that even the best policies will not pay for incidentals.
Never confuse liquidity with emergency corpus. A Mumbai-based financial planner said often his clients, who invest in shares, don’t understand the need for an emergency corpus. Equity shares are investments, which should not be liquidated to meet emergency needs.
Inadequate planning could also force you to borrow. Interest payments could affect your cash flow.livemint