You may have often been advised by your financial planners to invest a certain portion of your capital in emergency funds that enable you to meet unexpected monetary emergencies.
Emergency funds (also known as contingency funds) are that portion of your money that is useful at any given time when you are faced with sudden financial emergencies like medical expenses, travel plans, or temporary job loss. These expenses usually crop up abruptly and are difficult to manage through insurance policies or other means.
The size of these funds is dynamic, and you can restructure them every year owing to changing circumstances in your lives such as childbirth, new debt, house purchase, among others.
However, before you get drenched on a heavy rainy day, you must make sure that you have been mindful of your expenses else it would be difficult for contingency funds to come to your rescue.
For instance, if someone has invested a huge amount in mutual funds and sadly, he hasn’t been able to get the kind of returns that he anticipated before investing, then his money has been locked. In this scenario, contingency funds play a pivotal role in balancing your financial needs.
According to investment firm Franklin Templeton, having an emergency fund should be a priority for everyone while planning for a financially secure life. To cover unexpected expenses, emergency funds must be liquid. One should never put their emergency funds in investment options with a lock-in period as their money can get blocked. One should be able to withdraw the money when they need it without being penalized in the form of exit load or pre-withdrawal penalty.
The contingency funds are not only useful during emergencies but can also help in other ventures. For example, if you want to set up your small-cap business and you don’t have much funds. Sadly, the bank and other financial institutions have also been able to provide the kind of during which you require to kickstart your business. At that time, the contingency funds are of great help.
Not only that but several banks across the globe are wary about the uncertain times which can pose an economic threat to their business, therefore, many must be cautious about the possibility of succumbing to any unpleasant financial crisis. Certainly, at that time, contingency funds do play a big role and rather act as a protection cover.
Besides contingency funds, another option is to invest in low duration funds which are the open-ended debt mutual funds that invest in money markets and debt securities, with a duration between 6 to 12 months. These kinds of funds give high returns and are less risky. Apart from this, other investment options include fixed deposits (FD), savings account, or government-sponsored bonds. This guarantees you a safety net on your investments.
Though are many reasons why you need contingency funds at any point in time in your life, here are some points that delineate the relevance of contingency funds:
Challenging times: As we have seen how the COVID-19 outbreak has crippled economies, which has resulted in pay cuts and lay-offs across industries. So, you must structure your financial planning carefully. The best way to avoid financial hardships during unpleasant times is to draw a line between your needs and necessities. Unnecessarily splurging burns your pocket. So, proper monetary planning and curtailing needless expenses help in saving more money. That saving or precisely contingency fund can rescue you during your pressing times.
Significance of contingency funds: Often, the flow of money gets disrupted due to several reasons that include job losses, debts, company restructuring, and economic recession. No one can be certain about the time when you could get hit hard by massive financial hardships, even during that time, availing of a bank loan may look like a far-stretched task. Therefore, having contingency funds in place could take the burden away to a large extent. So, it is advisable to start investing in emergency funds in advance before the wind blows you off. Ideally, you can invest in contingency funds monthly and keep monitoring them till the time an adequate corpus is created.
Investing the appropriate amount: Once you plan to start investing in contingency funds, the important thing would be to decide the amount figure and frequency of payment. Also, it is equally pertinent for you to ensure the continuity of the payment as any break or disruption can lower the interest rate. So, it is wise to invest in contingency funds after calculating overall expenses and earnings for better investment planning.
Where to park your money in contingency funds: In an open market, investors often get confused about making the right investment choice. For short-term gains, the liquid mutual funds are the best option, as it comes with a maturity period of 91 days. Another good thing about these funds is they do not have any lock-in period.
Medical emergencies: There is no doubt that medical emergencies can knock on your door any time, no matter how healthy you are. It can come in the form of an untoward incident such as an accident or sudden diseases, etc. Perhaps if the disease or illness proves fatal, you need to either get hospitalized or undergo surgery. At that time, your medical coverage may not be enough or the cost will be huge, therefore, if your contingency funds are handy, then it will be a big relief and can be a life-saver.
TechNode Global publishes contributions relevant to entrepreneurship and innovation. You may submit your own original or published contributions subject to editorial discretion.
Featured image credits: Pexels