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Having a contingency fund or an emergency fund is considered to be the first step in financial planning process. Most of the people don’t understand the importance of having a separate fund for emergency. Based on the kind of lifestyle, one should plan for an emergency fund, which is recommended to be atleast 6 months of expenses. In this article, we have attempted to bring out the importance of a contingency fund, in the form of a case study.
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A wonderful sense of freedom and independence dawns on us when we start earning. We no longer have to depend on the pocket money given to us by our parents and have the freedom to make our own financial decisions. This feeling of being financially independent is very special and unlike any other. But, what a lot of us fail to understand is that being financially independent is hardly worth anything if it does not include being financially secure.
Now, you may ask what is the connection between being financially independent and financially secure? Let’s explain this by way of the following example:
Vishal, a young graduate from a reputed institute, was selected for a job in the corporate sector. He had to move to a rented accommodation closer to his office location. It was a bit expensive but he did not mind as it was a well-paying job.
He was very happy to receive his first paycheck. After taking care of his expenses, he decided to send some money to his parents. While they were obviously very proud of him for this nice gesture, they also asked him not to send them any more money and rather keep it for himself. They knew that since Vishal was living on his own in a big city, he would have a lot of expenses to take care of.
Now that he did not have the obligation to send money to his parents, he started becoming a bit complacent with regard to his expenses. His entertainment expenses shot up as he started spending more on eating out, movies, shopping and night-outs. Bowing down to peer pressure, he also took membership of a club he was not really interested in and had to pay a hefty membership fees for it. Soon, all of this became more of a habit rather than an exception.
He did not bother keeping a check on his spending nor making a budget of his monthly expenses because he thought he was earning enough to take care of his current lifestyle. He got so caught up with his ‘current’ life that he forgot to save and invest for the future. This proved to be his biggest mistake and for which he had to pay dearly.
A few months later, he met with an accident and suffered major injuries. He was hospitalized for almost a week and could not resume work for about a month after that. But his health was not his only worry at the time. His financial health had also suffered because of his complacent attitude. When the hospital bills came, he realized that he did not have enough savings to pay them. Worse still, he did not have a mediclaim policy that might have covered some of those expenses. Ultimately, his parents had to take care of the bills and his other expenses when he was not able to resume work.
Now, we can say that Vishal was financially independent because he was earning well, was able to take care of his expenses and did not have to rely on his parents’ money for his survival in a big city. But was he financially secure? NO. This is because he chose to spend all the money that he earned without giving a thought to saving and investing. His financial decisions were made in accordance with his current lifestyle choices. He had not bothered to think and plan about any future contingencies.
When his parents had asked him to keep the money for himself, they surely did not mean for him to spend it all on frivolous things. Rather, it would have been prudent on his part had he started saving some of that money and investing the rest. Unfortunately, he had to learn this lesson the hard way. But you do not have to make the same mistakes.
There are certain things that should always be kept in mind when you start earning, whether you are living independently or with your family:
1. Do not spend your entire salary at once or on frivolous things.
2. It is never too early to start saving and investing.
3. Whether you are earning more or less, it is always advisable to have a contingency fund. It is usually recommended to have 6 months of expenses in the form of a contingency fund. Remember to include all your expenses, including your EMI payments while calculating this amount. You need not keep this in the form of idle cash; invest in a liquid fund which can be easily liquidated in times of need.
4. Buy a health cover for yourself. When you are young and fit, the premium is far less. Also get a life insurance in the form of a pure term plan.
5. Start prioritizing your goals and plan your investments accordingly.
Remember, future cannot be predicted but we can try to lessen any unforeseen damages by staying financially prepared.
Vishal, a young graduate from a reputed institute, was selected for a job in the corporate sector. He had to move to a rented accommodation closer to his office location. It was a bit expensive but he did not mind as it was a well-paying job.
He was very happy to receive his first paycheck. After taking care of his expenses, he decided to send some money to his parents. While they were obviously very proud of him for this nice gesture, they also asked him not to send them any more money and rather keep it for himself. They knew that since Vishal was living on his own in a big city, he would have a lot of expenses to take care of.
Now that he did not have the obligation to send money to his parents, he started becoming a bit complacent with regard to his expenses. His entertainment expenses shot up as he started spending more on eating out, movies, shopping and night-outs. Bowing down to peer pressure, he also took membership of a club he was not really interested in and had to pay a hefty membership fees for it. Soon, all of this became more of a habit rather than an exception.
He did not bother keeping a check on his spending nor making a budget of his monthly expenses because he thought he was earning enough to take care of his current lifestyle. He got so caught up with his ‘current’ life that he forgot to save and invest for the future. This proved to be his biggest mistake and for which he had to pay dearly.
A few months later, he met with an accident and suffered major injuries. He was hospitalized for almost a week and could not resume work for about a month after that. But his health was not his only worry at the time. His financial health had also suffered because of his complacent attitude. When the hospital bills came, he realized that he did not have enough savings to pay them. Worse still, he did not have a mediclaim policy that might have covered some of those expenses. Ultimately, his parents had to take care of the bills and his other expenses when he was not able to resume work.
Now, we can say that Vishal was financially independent because he was earning well, was able to take care of his expenses and did not have to rely on his parents’ money for his survival in a big city. But was he financially secure? NO. This is because he chose to spend all the money that he earned without giving a thought to saving and investing. His financial decisions were made in accordance with his current lifestyle choices. He had not bothered to think and plan about any future contingencies.
When his parents had asked him to keep the money for himself, they surely did not mean for him to spend it all on frivolous things. Rather, it would have been prudent on his part had he started saving some of that money and investing the rest. Unfortunately, he had to learn this lesson the hard way. But you do not have to make the same mistakes.
There are certain things that should always be kept in mind when you start earning, whether you are living independently or with your family:
1. Do not spend your entire salary at once or on frivolous things.
2. It is never too early to start saving and investing.
3. Whether you are earning more or less, it is always advisable to have a contingency fund. It is usually recommended to have 6 months of expenses in the form of a contingency fund. Remember to include all your expenses, including your EMI payments while calculating this amount. You need not keep this in the form of idle cash; invest in a liquid fund which can be easily liquidated in times of need.
4. Buy a health cover for yourself. When you are young and fit, the premium is far less. Also get a life insurance in the form of a pure term plan.
5. Start prioritizing your goals and plan your investments accordingly.
Remember, future cannot be predicted but we can try to lessen any unforeseen damages by staying financially prepared.
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