Contingency Planning – Smart Tips

We all have financial goals in our life. There could be many – making provision for your child’s higher education and marriage, creating a retirement fund to take care of your golden years, to buy primary home or a second property, to buy your first car or a new car, to go for that one big holiday – the list seems endless. One common feature here is that none of these goals is immediate or unexpected. Expect few goals most others can even be postponed, preponed or compromised to some extent. 

What is contingency planning?

So we all make investments towards achieving these financial goals of ours in best of our ability. So these goals remind us about our future probable expenses (based on some assumptions). But there could be other scenarios also where expenses are unknown and immediate – cannot be postponed or compromised. Planning or provisioning for such scenarios is known as CONTINGENCY PLANNING.

The most frightening scenario can be loss (partial or full) of income. This can happen due to loss of job or pay-cut or postponement of salary payment. Are not we aware of what is happening with many of our friends in Kingfisher Airlines? How are their families surviving? There could also be fatal accidents or one can fall critically ill – I agree that such thing may or may not lead to a loss of job always but it will surely have an adverse impact on someone’s family budget. Again, not all of us are salaried persons here – many of us are self-employed also.

So the unexpected events for which we need to do a Contingency Plan can be many. Whatever we have discussed so far, can be summed up here:

(1)    Loss of job / income
(2)    Downward revision of salary or pay-cut
(3)    Postponement of salary payment
(4)    Fatal accidents
(5)    Critical illness

Can you think of any other scenario adding up to this list? Please mention that in the comments below.

How can you plan for such unexpected events? Or, what should be the size of your contingency fund?

One thing we must admit that there are certain expenses which cannot be avoided or stopped or reduced even under the above scenarios. What are those? Those could be under the head of food and groceries, utility bills, education expenses, home expenses – rent / EMI, car and other loan EMI, insurance premiums.

You may say that you have investment expenses also like all those SIP investments that are currently running – are not those important? Of course those are important. But those can be stopped or postponed in worst cases. It would really be nice if your contingency fund is big enough to take care of those running SIPs also. One thing we must remember here that whatever money we are going to park in a contingency fund is going to earn no return or very less return as liquidity is always the topmost priority there. So in a way you can look at contingency fund as an ‘opportunity loss’. But at the same time we cannot do without it. So we should not go overboard while creating the contingency fund. It should have provision for expenses which cannot be stopped, avoided, postponed or compromised.

Your contingency fund should take care of all these expenses for minimum 3 – 6 months.

Where should you park money to create a contingency fund?

There are three priorities here – liquidity, liquidity and liquidity! 4th and 5th priorities can be ease of investment and return. The money that is there in contingency fund should be accessible all the time. This is very important. What form of investment is most easily accessible? Cash. But this earns absolutely no return and risky also. Next is keeping money in your savings bank account, which can be accessed any time through ATM. And that is why this is the most popular option and often recommended by professionals to manage contingency fund. Some banks offer fixed deposits with features like no penalty on withdrawal and can be accessed through regular ATM. They name it differently. Some banks call such deposits – flexi-fixed deposit. This is also a good option. Another option of parking money is liquid fund. Redemption from a liquid fund will take maximum two working days.

Whatever we have discussed here, can be summed up as:

(1)    Cash
(2)    Savings bank a/c
(3)    Short term / Liquid Fixed Deposit
(4)    Liquid Fund

You can create your contingency fund using the above instruments any combination you are comfortable with.

It is ok if you take time to build your contingency fund. Sometimes it takes even a year or so, but once it is created all you need to do is to maintain it and review periodically in respect to changes in your income and expenses. During the time when you are building your contingency fund and even later, credit card can also be a very useful tool in contingency planning, provided you know how to manage one. More on that later.

Are you done with your contingency planning? Have you built up your contingency fund? It would really be nice if you can share your experiences with us. Please leave your comment below.