An all-weather protection

It's better to go through some austerity, instead of paying interest in leisure.

Every emergency is like an unwelcome visitor. Sudden household expenses, loss of employment, medical situations, demise of loved ones, come with a certain level of stress and anxiety. Though we can't prevent emergencies from occurring, we can surely save ourselves a lot of headache by being financially prepared by having a contingency fund in place.

Starting up
The best way to start is by putting aside a certain amount of money every month for this fund. But where does one invest? Whenever an emergency arises, you will need immediate access to money. Moreover, you don't know when you will need these funds.

Therefore, it is best to avoid investing the corpus in volatile assets such as equities or equity mutual funds, since they might be down in value at the time of your emergency. The avenue I prefer most are liquid funds or short- term debt funds, which provide a great degree of capital stability with a current rate of return of 6-7 per cent per annum.

The funds in them can be accessed very easily, in a day or two. However, a note of caution here. Since this fund is so easily accessible, one should be disciplined enough to not resort to this money to fund impulse spending.

Getting into the motion
One should set up a systematic investment plan into such funds, via auto debit route. This means that at the beginning of the month, as soon as you get your paycheck, the predetermined amount will be debited from your salary account and invested in the fund.

This may sound tough, but that is the only way one can have the discipline to invest regularly in this fund. This will help build up the fund over the predetermined period to reach the target corpus.

What is the goal?
The size of contingency fund depends on one's personal situation. If one is single, or married and the spouse is also working, the fund can be smaller.

However, if one has a seasonal or uncertain job, is self- employed, has a family to take care of, the fund corpus should be larger. Ideally, the contingency fund should cover 3-12 months of expenses, depending on one's situation. When you calculate your monthly expenses, don't forget to consider expenses that arise quarterly or annually like property and personal taxes, insurance premiums, membership subscriptions, festivals and holidays.

Taking it another lap
Set up another fund to meet non-monthly payment commitments. Calculate your monthly expenses with and without these other expenses. Deduct the latter from the former and the balance would be the funds you would need to pay during the year, but not this month.

Make a similar transfer of this money into a separate fund by the same process as a contingency fund. This will help you meet all your payment commitments timely without being tempted to spend the money.

When in debt or doubt
In this day and age of consumerism and leveraged spending, many people are already in debt. For them, it does not make sense to be paying 15-16 per cent per annum. On a personal loan or 30-40 per cent per annum on a credit card outstanding, while saving in a contingency fund at 6-7 per cent per annum.

For them, the best thing would be to pay off their loans as soon as possible and then start building their contingency fund. Even if one is in debt, one should have a contingency fund of at least a month's expenses to meet any sudden emergencies, since being in such a leveraged situation, one may not have access to any further credit.

For those not in debt, having a contingency fund in place has all the more reason for them to stay out of the debt spiral. Since most of us run on a tight monthly budget, paying off these debts would be very difficult and they would keep growing.

Therefore, it is better to go through some austerity and save a little every month to build up this fund, where you earn interest, rather than borrow in an emergency and pay high rates of interest.

Inner thoughts
To sum up, a contingency fund is an imperative tool to protect oneself from financial uncertainties. It is natural for one to feel more confident and self- sufficient when one has such a fund in place. During emergencies, the emotional stress is so great that it really helps if the financial stress is taken care of. Creating and maintaining such a fund is not easy.

It requires a lot of sacrifice and discipline. Having said that, the satisfaction one gets in knowing that one is financially prepared for emergencies far outweighs the sacrifices made to get there.

(The writer is a Kolkata-based financial planner and can be reached at rishi@touchstonewealth.com)