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Have You Built A Rainy Day Fund Wisely? - Outside View by PersonalFN

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Have You Built A Rainy Day Fund Wisely?
Jul 13, 2018

Last week a very close friend of mine lost her job. It was a shock for her and for all of us. She was working with that organization for 8 years. And you know how it feels when you give almost everything to an organization and it does not take a while to lose all of that.

Well, that is how it is. It is a sad reality. Life is and has always been uncertain.

The only thing we can do is, while we hope for the best, even plan for the worst; because life is full of ups and downs.

[Read: The 3-Step Guide to Building A Liquid And Secure Emergency Fund]

Thankfully, my friend was financially prepared for the rainy day. And she was grateful for having planned well for such contingencies.

Have you built a rainy day fund for yourself?

Emergency situations like loss of job, hospitalization, unexpected rise in your child's school fees, etc. can arise at any moment and leave you high and dry.

You ought to prepare yourself financially whereby you possess a sense of security and strength to overcome some the testing times.

Building a contingency fund, also known as emergency fund or rainy-day fund, is very important to handle exigencies or uncalled events in life, so that you meet all your expenses and survive during difficult times.

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Here are 4 things to do to build a rainy day fund...

  1. List Down All Your Expenses

    While creating a contingency reserve, consider all your avoidable as well as unavoidable expenses, such as household expenses that fund your basic needs, utilities, medical expenses (if you or your family member is on regular medication), travel expenses, children education expenses and so on.

    Do not ignore any expense at this point. So, include even the loan EMIs you pay. Skipping EMIs may not reflect well on your credit worthiness and affect your Credit Score.

    Watch this below video on Cashflow Management:

  2. Calculate Your Contingency Reserve Requirement

    Ideally, you must maintain at least 6 to 24 months of living expenses, including EMIs as your contingency reserve.

    You may add a little 5%-10% extra for medical emergencies, taking cognizance of the health insurance and medical record of you and your family members.

    Now, though big is better, maintaining too much money as contingency in a savings account or low interest-bearing investments, may not be wise as the objective of countering inflation would be lost.

  3. Invest Sensibly

    Note that your contingency fund is to meet expenses on a rainy day; hence the avenues you choose to park this money should be liquid and relatively safe.

    So, here are few avenues to park your rainy day fund:

    • Savings Bank Account and Short Term Deposits:

      Well, this is an age-old and easiest way to park short-term needs, and even keep aside some money to manage contingencies. You'll earn around 3.5%-6% p.a. interest, depending on the bank you opt for to park your savings.

      But if you wish to battle inflation (which erodes the purchasing power of your hard earned money) while managing your short-term liquidity, you may consider recurring deposits (RD), Fixed Deposit, a Sweep-in Account, or a Flexi/Recurring Deposit. The interest rates will be a few percentage points higher than the savings interest you earn.

    • Liquid or Money Market Funds

      Liquid funds are open-ended debt mutual funds that primarily invest in short-term money market instruments with maturity upto 90 days. Liquid funds invest in money market instruments such as Certificate of Deposits (CDs), Commercial Papers, Term Deposits, Call Money, Treasury Bills and so on. Therefore, liquid funds entail less risk.

      Since most liquid funds do not have any exit load, you can exit any day, without any penalty. On withdrawal, the redemption proceeds are credited to your bank account within few hours (provided it's a working day).

      [Read: All You Wanted To Know about Liquid Funds Is Here]

    • Liquid Plus or Ultra Short Term Debt Funds

      Ultra short-term debt funds invest in instruments with higher durations as compared to liquid funds. As the duration is slightly higher, the risk is slightly higher as well; but they have the potential to yield higher returns than those clocked by liquid funds.

      While most of these funds do not carry exit load, there are some ultra-short term debt funds that have an exit load period of 7 to 30 days. Hence, money that may not be required within 3 to 6 months can be kept in these funds.

    • Floating Rate Funds

      They aim to generate returns in line with the prevailing interest rates and are suitable to hedge your corpus against interest rate risk.

      While these funds carry a lower interest rate risk, they are meant for investments with a time horizon of around 6 to 12 months.

    • Short Term Debt Funds

      Your emergency corpus may lie idle for a period of 3 years or 5 years at a stretch. While this is definitely a good thing, you also need to plan the allocation of your investment portfolio accordingly. Hence, you could consider Short Term Debt Funds, which invest in instruments for duration of around one to two years.

      Note that many short-term debt funds may attract an exit load if redeemed within 6 to 12 months. So, ensure a small percentage of your fund is allocated to such funds.

      What could be the ideal mix?

      Ideally, up to 50% of the emergency fund should remain highly-liquid by keeping it in a savings account or a mix of a savings account and liquid funds with an instant redemption facility. The remaining corpus can be invested over the other products.

      Always remember, it is not the job of an emergency fund to earn a high return. The job of an emergency fund is to be there in an emergency. Hence, ignore suggestions of investing in hybrid mutual funds that have a marginal equity exposure such as monthly income plans (MIPs) or capital protection funds.

      [Read: The Best Aggressive Hybrid Funds (Earlier Balanced Funds) For 2018?]

  4. Review Your Contingency Fund

    At times life events such as marriage, divorce, child, and so on have a bearing on your contingency requirements as well.

    Similarly, if you have applied for a new loan then you need to take onto account the EMI expenses and accordingly increase your contingency fund too.

    PersonalFN believes that change is inevitable and procrastination is the enemy. It is vital for you to recognise that merely creating a creating a plan to build a contingency is not enough. Timely reviews are imperative, at least once a year.

To Conclude...

If you do not have a contingency fund yet, it is never too late to build one. But you surely cannot ignore to have one. Because emergencies can come knocking at the door at any time. Hence, be prepared and build a contingency fund today!

Remember the old adage, 'A stich in time saves the nine'. Put in efforts now and deal with the problem right now rather than waiting till the end.

If you want handholding in planning your contingency requirements and accomplish the vital financial goals of life, reach out PersonalFN on 022-61361200 or e-mail at info@personalfn.com. We will be happy to hear from you.

This article first appeared on PersonalFN here.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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