Bengaluru-based IT professional Amit Kumar, who worked at the R&D centre of an American multinational company, had been doing well in his career. But one fine day, he was informed that he had been laid off as part of a global restructuring programme. The company gave him four months salary as compensation.
Kumar, 40, was shocked. He had a family to support—two school-going children and a homemaker wife. He had recently invested in a two-bedroom apartment in the city and had EMIs to pay. The severance package was just not enough to sustain him till he got another job. Kumar, however, had a habit of saving regularly for a contingency fund. And that was enough to manage for at least a year. Kumar landed a job in a few months, though not at the same level. The only thing, according to him, that helped him deal with the crisis was his contingency.
“One needs to do away with the ‘nothing-will-happen-to-me’ attitude,” said Sasikumar Adidamu, chief technical officer, Bajaj Allianz General Insurance. “Appropriate financial planning is important to live a life of dignity. One never wants to be in a situation where one has to borrow money to fulfil basic necessities or live hand to mouth. To avoid such situations, it is vital to have a contingency fund set aside that helps you deal with emergencies.”
Personal finance experts unanimously agree that contingency financial planning is a must. There can be unforeseen expenses in every sphere of life—a medical emergency, job loss or transfer. Prudent systematic saving and investing in various financial tools to meet such emergencies is an important part of maintaining financial stability.
While nothing can prepare one enough to face an emergency, having an emergency fund is the best one can do. “If one does not have an emergency fund, one should start working on one,” said Navin Chandani, chief business development officer, BankBazaar.com. “Ideally, it should be six to twelve months of your current monthly income kept in a risk-free and liquid instrument such as a fixed deposit. This emergency fund can help in situations such as loss of regular income. Try not to utilise this money for any other expenses.”
The objective of having a contingency fund is not limited to meeting unexpected events—one can channel it through planned events like job switch or marriage. “Those who don’t have a contingency fund should reconsider their monthly budget allocation, and try to minimise or cut off unwanted expenditure,” said Dinesh Rohira, founder and CEO at 5nance.com. “It is prudent to shell out at least 10 per cent of monthly income into an emergency fund, and gradually top up until it is sufficient to meet six months' expenditure. Nevertheless, it can also go beyond six months but it will block the money which can be deployed for wealth creation purpose. After reconsidering a budget, one should park this fund in a liquid scheme of debt mutual funds, and use it only for emergency purposes.”
An emergency fund is one of the most important aspects of any financial plan. While you put together one, you should factor in expenses such as payment of insurance premiums and EMIs. The contingency fund should ideally be parked into a separate bank account or liquid fund. “It is very common for people to panic in a state of confusion when faced with an emergency,” said Rahul Jain, head of personal wealth advisory at Edelweiss. “The first step is to utilise whatever savings or any investments one has rather than taking a personal loan or loan from friends or relatives. Within investment one should utilise the bank fixed deposit or any other fixed income instrument. Only if there is additional need of funds should one dip into long-term investments like stocks and equity funds. Personal loan should be the last resort.”
Job loss is one of the major reasons that land people in financial trouble. It can shatter them financially and emotionally. “If you have recently suffered a job loss, then the first step must be to reenter the job market,” said Chandani. “Full time, part-time, freelance, keep your options open. At the same time, cut down your expenses as much as possible. Stick to the essentials and cancel or reduce spending such as online subscriptions, eating out, buying gadgets, or travelling for leisure. Also, use your investments with care. Resist the urge to withdraw all money at once. Withdraw them in a structured manner according to your needs. Once you find employment again, make sure to put the money back in the investments. If you’re repaying a loan, you may be bound by contract to inform your lender about a change in your employment status. If you can continue to pay your EMIs, do so. But if you are struggling, work with your lender about increasing your tenure, lowering your EMIs, or any other way the loan can be restructured. Try not to let your insurance policies lapse. Most insurance companies offer you a 30-day grace period in which you can make your premium payments. Use this grace period to pay off your premiums.”
Another scenario in a salaried individual's life is changing a job for better opportunity, which leads to loss of primary source of income for a small period of time. It, however, may go longer than expected, leading to financial implications. In such a scenario, a person can use the emergency fund to meet the needs.
If the dry period lasts longer than you can manage with the contingency fund, you can opt for short-term loans. However, make sure you pay back the loan on high priority after getting a stable income.
Accidents and natural calamities can also lead to financial distress, and preplanning can help manage such events. A prudent approach is to insure oneself against such events with appropriate cover, and keep enough money aside to finance this policy.
Health care can be a major challenge in the absence a regular income. “If you are out of a job, you will not have your employee insurance to help you tide over. So always have your own, independent health insurance policy for your whole family in addition to whatever your employer provides. Also, consider a term plan if you have dependents. These are pretty low cost, and can provide you cover in case job loss occurs due to an accident or disability,” said Chandani.
Adidamu says health care costs can add immense pressure to a person's finances. “There is an increase in medical costs of at least 15 per cent annually, considering the inflation. Most of the people pay these expenses out of their savings, borrow money from their relatives or even sell their jewellery or assets. It is important to have a holistic 360 degree health insurance plan for yourself and your family members to deal with medical emergencies. One needs to have a basic health insurance plan of at least 05 lakh, considering the current medical costs along with a super top-up health plan that takes care of hospitalisation expenses in case the sum insured of the basic policy is exhausted. With change in lifestyle there’s also an increase in the number of people prone to critical illness. A critical illness plan provides you a lump sum amount in case you are diagnosed with the listed illness in the policy and it not only helps you with recovery, but also supports your family members,” he said.
People put in their lifetime's savings and pay huge EMIs to build houses, probably their most important asset. Then they spend huge sums on decorating it and to buy household items. One natural calamity can wipe off all this. A home insurance ensures that your years of labour does not go in vain and covers your home from dangers like theft, damage due to natural calamities and accidents. It not only covers the structure, but also the contents within.
Accidents can inflict serious damage on a family's financial health, more so if an earning member is involved. A personal accident cover can provide the much-needed financial support if a person meets with an accident that leads to disability or death. It is a benefit policy that also provides for children's education and medical expenses. This cover is an absolute must in addition to a life insurance policy that covers all causes of death.
The habit of planning finances needs to begin early, ideally right from the first paycheck one receives. So does a contingency fund. “One of the components of financial planning is adequate saving, which is invested in the right place to achieve growth so that when contingencies or emergencies arrive, one has a sufficient nest egg built up to tide over it,” said Dheeraj Singh, head of investments at Taurus Asset Management. “The fundamental principle of not spending more than one earns is sacrosanct. Even if one does take on debt to finance a big asset purchase, one should ensure that there is sufficient cushion in income to take care of servicing the debt. To build up a contingency fund one needs to start saving and investing early and spend only on things that one needs and not on things that one wants. Besides this one needs to invest in suitable instruments for growth. For instance, SIPs in mutual funds are a great disciplined investment mode to ensure long-term growth. Similarly, regular income needs can be taken care of through systematic withdrawal plans, which are also tax efficient. Also, one should prefer investing in liquid instruments (instruments that can be converted to cash quickly and easily) as opposed to illiquid instruments.”
Identifying and segregating your expenses as discretionary and non-discretionary is how you start with saving. “Consider your monthly household expenses, EMIs, school fees, medical expenses, etc. Buy a term plan and adequate medical cover and start saving for taking care for a minimum of six months of your non-discretionary expenses, invest them either in liquid fund or you can keep the same in a savings bank account as well,” said Rajesh Patwardhan of LIC Mutual Fund. “Save it in a separate bank account and try to add some money every month in the same. In case one has not planned for such a fund and an emergency arises, there are little choices left, but one has to be extra careful not to fall in debt trap. So either go for peer-to-peer short term borrowing or family borrowing, or selling family gold or going for loan against property or outright sale of property. Staying away from the debt trap will help you overcome the contingency period quickly when the bad phase passes. There are insurance policies available to cover such expenses, and if one feels he is into an unstable job and not in a position to build such a fund one should buy such a policy.”
Some experts are of the opinion that, if you don’t have a contingency fund, credit cards can prove to be helpful to pay for any financial emergency. “It is, however, not recommended to keep the credit card bills outstanding for long periods of time as it could be quite expensive,” said Raghvendra Nath, managing director, Ladderup Wealth Management. “Nowadays, many banks offer pre-approved personal loans depending on the financial track record of the individual, which could be at a very reasonable rate of interest. Other than this, if an individual owns gold jewellery, he can take a gold loan to deal with the short-term financial crisis. Also, if he has made any investments in mutual funds, equity shares or bonds, he may look to liquidate the investments to meet his financial emergency.”
Nath suggests one should keep at least nine months of expense requirement in liquid mutual funds or fixed deposits as an emergency fund. “Critical illnesses like cancer or tumour can also lead to high bills of surgery, medicines and hospitalisation together with no salary income. While health insurance policies can cover the individual for the expenses, the insurance claim can take two or three months to clear. In this case, the emergency fund would be required to cover the medical expenses in the absence of cashless health insurance policy and to meet the routine expense for the family without compromising the lifestyle. Also, as of now, none of the insurance companies offers a standalone job loss insurance policy. However, it is available as an add-on with other polices that cover larger risks such as accident and critical illness. The job-loss rider would cover an individual only in case of retrenchment by employer due to merger or acquisition. Considering the narrow scope of the cover, job loss insurance add-on does not seem to be a dependable option.”
Before buying any insurance policy as protection against contingencies, one should review and understand all the conditions mentioned in the policy documents and disclose accurate facts to avoid any delay in the claim settlement process. “Also, one should pay all his insurance premiums on time to avoid policy being lapsed,” said Nath.
Health insurance and critical illness plans need to be chosen carefully. “Though a health insurance plan (indemnity) typically covers expenses incurred during hospitalisation, pre and post-hospitalisation, a critical illness plan offers cover upon diagnosis of critical illness, where the insured can get lump sum benefit that can make up for his reduced earning capacity as a result of contracting the critical illness and can help his family to manage the cost of expensive treatment of critical illnesses. One needs to have a minimum hospitalisation insurance cover right from birth or young age,” said Shreeraj Deshpande, principal officer and key managerial personnel, Future Generali India Insurance.
Seeking a temporary credit line against mutual funds or stocks could also be considered in case of a financial emergency besides borrowing against traditional insurance policies or withdrawing from the provident fund kitty. “An individual can also redeem the most liquid asset class or fund category with the least loss and least exit cost,” said Shaily Gang, head of products, Tata Mutual Fund. “In the absence of financial assets, it will be difficult to tide over this situation, as physical assets would not be easy to liquidate immediately. Thus, it is extremely important to build a corpus by investing in mutual funds, SIPs, planning asset allocation basis risk appetite across equities and equity mutual funds, fixed income funds, bonds, provident fund and alternative assets. Also, cash balance in bank accounts and fixed deposits would be the first thing to come to the rescue in a financial emergency. Credit cards could be used for paying medical bills or making payments provided the person is mindful of the interest-free period available on the credit card. In case of a medical emergency, liquid funds redemption can be executed or a cashless mediclaim process can be initiated.”
There are some additional precautions that one needs to take in managing an emergency fund. “All bank accounts and investments should be easily accessible to more than one person in the family,” said Gang. “The best way is to maintain proper files with CAS reports, FD details sheet and policy documents. Expiries and renewals of policies should be tracked. Utmost care should be taken while making disclosures on policies, providing details while applying for policies and also while subscribing to any kind of investment. Return seeking should not take precedence over safety and liquidity while parking funds as contingency or emergency reserve. The investment objective of contingency funds is to keep the portfolio safe, liquid and then try to earn returns which are slightly higher than bank savings, current and short-term fixed deposits. Besides this, health insurance, mediclaim and term life insurance should be applied for in the life cycle. Also, a minimum of 50 per cent of the portfolio should be open ended. Nominations for all investments should be in place. Ideally, a will should also be planned and executed.”
While selling existing investments to meet an emergency fund requirement can save you from interest cost, it can adversely impact your long-term financial goals. “Redeeming market-linked investments during bearish market conditions can also lead to book losses,” said Naveen Kukreja, CEO and co-founder of Paisabazaar.com. “Those availing loans to deal with financial emergencies should visit online financial marketplaces to compare various loan offers available on their credit score, income and other parameters. Among various loan types, personal loans have the fastest disbursal time with most lenders disbursing personal loan within a few days. Their interest rates start from 11 per cent and their tenure can go up to five years.”