Financial Planning for Contingencies. How to make a contingency plan?
In the previous article, we discussed what is emerging market ETFs?. In this article, we will talk about financial planning for contingencies
A contingency is the possibility of future adverse events such as the recession, natural disaster, fraudulent conduct, terrorist attack, or an epidemic.
COVID-19 is the perfect example of a contingency. Businesses were devastated by the coronavirus pandemic in 2020. Some let go of employees, some required many employees to work from home while others struggled to cope with the changing economic sphere.
To counter contingencies, businesses and investors must adopt some extra safety precautions. Although you can plan for the contingencies, the form and breadth of such unfavorable events are rarely known ahead of time.
Companies and investors prepare for various scenarios by analyzing risks and putting preventive measures in place.
A well-thought-out contingency plan reduces the amount of money you might lose because of an unexpected adverse event.
What is a contingency plan?
A contingency plan or a contingency fund covers your day-to-day expenses in the event of a financial emergency, such as a job loss, medical expense, or any other unpleasant condition or occurrence that results in a temporary financial loss.
Let us take an example of what a contingency fund should look like. Say X needs Rs 50,000 to meet his monthly expenses. His household expenses are Rs 15,000, his child’s tuition fee is Rs 5000, his loan EMI is Rs 20,000, and some personal expenses at Rs 5000, which add up to a total of ₹50,000.
In this scenario, X would be good to set aside some money as a contingency reserve for his necessary monthly expenses. He needs to invest that money in a reasonably liquid product because it is held for an emergency.
How can he figure out how much money he needs to set aside as a rainy-day fund? As a rule of thumb, it should be enough to cover at least six months of his necessary monthly needs. To be on the safer side, this can be done for a year.
To establish his contingency, fund X can save rupees 25,000 a month for a year. He can also invest this money in a Flexi-deposit or a liquid mutual fund rather than leaving it in a savings account.
Liquid funds offer better returns than bank savings and have no entry or exit loads.
Knowing that you have a contingency fund will assure you that you can keep your investments and financial planning on track, even if your regular cash flow stops or decreases momentarily.
How to make financial planning for contingencies?
The steps involved in formulating a contingency plan are to analyze what risks you might face in the future. It could be a job loss, a shift of a job, or anything of that sort.
And by that, you need to create a contingency fund. Then, creating a fund will require you to cut your expenses for a few months.
For example, if you want to save 3 Lac rupees as a contingency fund. You must cut some of your monthly expenses and transfer them to a different account as a part of the contingency fund.
These are the two basic steps that need to be considered to fulfill this requirement.
Consult an expert advisor to get the right plan for you
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