Contingency/Emergency Funds is not a new concept, and we Indians have known this for ages. I remember my elders saying 'Beta Bure Samay K Liye Hamesha Bacha K Rakho". But, does the younger generation of Indians follow this advice or have they simply forgotten it, I doubt that. But the recent Covid-19 crisis (a black swan event of the history of the world) and its implications have forced me to think this over again.
COVID-19- Economic Crisis
As we all know the world is going through a health crisis- Corona Virus/Covid-19 pandemic, coupled with a very unique economic crisis due to prevailing lockdown across the globe, it has halted the supply chain as well as the consumer demand.
This global event has also created an aura of stress and mental breakdown around it. Humans are designed to be social animals and are very susceptible to deprivation of human interactions, moreover, all our life activities are also social in nature, due to the lockdown, a large number of small traders have faced bankruptcy and debt crisis. The mental stress coupled with debt obligation has been a major for depression and mental breakdown.
From an economic point of view, it is peculiar to observe, why people who had a great lifestyle 3-6 months before were not able to survive for a small period of crisis i.e 3-6 months. I must be because they hadn't planned their financials well, resulting in a financial crisis and eventually mental breakdown and depression
First Principle of Wealth Creation - Pay Yourself First (Savings)
In this article, I briefly introduce two basic principles- i) Pay Yourself First (Savings), and ii) Contingency Funds; with focus on how to make the contingent funds and where to invest the same. George Samuel Clason in his book 'The Richest Man in Babylon" first published in 1926, has beautifully described the importance of the principle of 'Pay Yourself First" with the help of a story of ancient times wherein he describes how a young boy from a very poor family in Babylon becomes the richest man of Babylon, by following two golden principles
- Pay Yourself First and
People from all the age groups and all the economic backgrounds, if they follow the first principle 'Pay Yourself Self' then they would never fall into the trap of debts and stress, or not having ample funds to meet out their financial liabilities, the author in his book recommended to save at least 10% of the monthly income but in the current scenario with a high rate of inflation and growth rate of all the countries it is advised to save at least 20% of the income, same is also advised by the financial advisors.
It is advised that the young Indians who either have joined their first job or are going to start their first job, try to save 50% of the income for at least two years in their initial career, towards contingent funds, as it becomes difficult to save later on.
Contingency /Emergency Funds How To create and where to Invest
Let's discuss the most important aspect of this article, inclined Contingency funds/ Emergency Funds. These are the funds that should be saved and invested by the family/earner of the family to meet the unforeseeable expenses of the family arising out of the events beyond his/her control, for example, Medical Emergency, Job Loss, a pandemic, etc. Financial advisors differ on the number of contingency funds which a family should have some say it should be 3-6 months of expenses of the family, while others say 6-12 months of the expenses of the family and even some say it should be around up to 2 years of your expenses.
Did you notice one thing? They may differ on the quantum of the contingent funds but every financial advisor states, it is must-have a contingent fund, this can be explained with a beautiful quote 'The most powerful thing about time is, it changes". So, everyone should prepare himself in a way that he/she can easily come out of the bad times.
In my view every person/family should have 6 months of their family income as contingent funds as we Indians generally forget to account for expenses i.e Festival Expenses, attending various wedding expenses, annual insurance premiums paid for tax saving, etc in our monthly expenses calculation which may result in less adequacy of the Contingent Funds.
Once, we have decided to make Contingent funds then the most important questions arise where should it be invested so that it has liquidity, capital protection, and beats the inflation, otherwise, we will always be stuck in the 'chakravyuh' of not having adequate contingent funds and wouldn't be able to attain the peace of mind and other long term financial objectives in life. With years of finance experience and interaction with various financial advisors I have developed a strategy that might help you as well as assuring safety, liquidity, and growth of your contingent funds.
1. One month of Salary/income should be kept in Saving Account/Bank FDRs with maturity less than 91 Days
2. Invest the remaining amount in two or three below mentioned Mutual Fund schemes:
a) Liquid Funds (Debt)
b) Ultra Short Bond Fund (Debt)
c) Low Duration Funds (Debt)
d) Arbitrage Funds (Equity)
e) Short Term Income Funds (Debt)
An investor can read about the aforesaid schemes in detail on Click Here.
While choosing these funds investors shouldn't chase the return rather his focus should be Money Paramount, an investor should set the principles which shall not be broken under any circumstances unless emergencies.
1. Invest with those Asset Management Companies (AMCs) which are among the top 5largest AMCs as per the Assets Under Management (AUM).
2. The portfolio of Debt Oriented scheme should at least contain 80% AAA rated Papers.
3. Have One Scheme of One AMC i.e Diversification of the risk.
4. The history of the Portfolio Manager should be sound.
5. No Exit Load should be there or if it is there, it should be minimal.
6. If you are choosing Arbitrage Fund then look at the AUM of the AMCs and choose among the top 2 two largest AMCs with AUMs, based upon their Expense Ratio.
By deploying money in the aforesaid schemes, instead of keeping in FDRs, you can easily generate an extra return of at least 1.5%-2% return on your contingent funds which would be further enhanced for individuals having higher taxation by at least 1-2 % that shall be discussed in another article.
When should money be withdrawn from the Contingent Funds:
1. Medical Emergency which can not be taken care of by your health insurance.
2. Loss of earnings (Job Loss/ Closure of Business)
3. Any other contingent expenses which otherwise you don't pay will lead you in the trap of debt.
When should money not be withdrawn from the Contingent Funds:
1. Purchase of unproductive assets: Own house, car, jewelry, etc. as the same can wait.
2. Marriage: Your Marriage, your sibling's marriage as lavishes of functions may be reduced but your contingent fund will not come again once gone.
3. Avoidable Expenses: Long pending demand of your partner or kids to please them, Lavish Honey Moon/Dinner, Throwing a lavish party on KuaPoojan, etc.
4. To make Quick Money: People do irrational trading/gambling just to be quick billionaire which leads them into the trap of debt.
By following the simple two principles (a) Pay Yourself First (b) Have adequate Contingent Funds, we can together move our first step towards the attainment of financial freedom which shall assist us to face such kind of black swan events in a much stronger way allowing people not to commit the suicide in next black Swan Event, just because they didn't plan their finances and had no contingent funds.