How To Set Up A Contingency Fund

Written on September 18, 2007 by Tezza

Tuesday’s weekly guide to Personal Finance from 4EvaYoung.com

“Expect the best, plan for the worst, and prepare to be surprised.” – Denis Waitley

Unexpected stuff happens all the time. Circumstances outside of our immediate control often occur when we are least prepared. The car breaks down, the roof starts to leak during the storm season, you unexpectedly get laid off from work, your child gets sick or any number of other unimaginable curve balls that life throws at you. So it is little wonder that generations before us understood the need to save something away for the eventual rainy day.

Why Do You Need A Contingency Fund
“All days are not same. Save for a rainy day. When you don’t work, savings will work for you.” – M.K. Soni

My friends use to laugh at me in my younger days when I was naive and some might stay stupid. I lived quite literally paycheck to paycheck. In fact I managed to go into debt still and hence why it seemed humorous to my friends especially those who I used to work with as they knew all to well why I was turning up to a job I hated everyday. We all laugh about it now, largely because I didn’t realize how close to the knife edge I was living at the time. Any small number of financial shocks could have meant financial ruin for me, although to be fair I didn’t have all that much to lose. But the stress of juggling my bills and stretching the last dollars in my account before my next pay day still give me shivers. I can feel the beads of stress starting to form already reminiscing about those days.

So it’s not surprising then that one of the concepts that made sense years later when I became interested in my financial journey was the need to setup a contingency fund to buffer myself from unforeseen financial shocks. Most financial experts seem to banter the logical need to create a contingency fund and they’ll likely feed you a whole lot of financial hogwash and gobble gook.

The simple reason why you need a contingency fund is that life is a blink away from Murphy’s Law rearing it’s ugly head. You know the one “Whatever can go wrong will go wrong, and at the worst possible time, in the worst possible way.” Unless you want to become a real life testimony to Murphy’s Law then you want to get your contingency fund created. If your still not convinced then consider that it’s going to allow you to sleep better at night knowing that your cushioned against life’s little mishaps.

How Much Do I Need To Sock Away In My Contingency Fund?
“The safest way to double your money is to fold it over and put it in your pocket.” – Kin Hubbard

An often held misconception is camels store water in their humps. Well at least that’s what I thought. Low and behold I was wrong. In fact the camel stores fat in their humps. If the camel doesn’t eat for absolute ages, it’s fat stores are absorbed as nutrition to enable it to survive longer. Don’t we all need a “camel hump” which we can tap into during lean times or hard times.

Just as with camels the size of it’s hump is different from one to another. Some camels have one hump while others have two, the size of your contingency fund will largely be determined by your individual need. The implementation of some arbitrary figure like 6 months worth of savings and the like often don’t take into account your circumstances so it’s better to use it as a guideline rather than a hard and fast rule.

Consider some potential disasters that you want to be prepared for and come up with a figure to have in your contingency fund that will enable you to absorb those situations. Remember, your contingency fund is for emergency use. It’s not your savings and financial plan. You want to have access to short term emergency funds while putting other savings towards creating an asset base for your long term financial future. So if you want to have a contingency fund that will represent 6 months worth of household expenses should you become ill or lose a job than that’s the goal you should aim for. If on the other hand your comfortable with 3 months than no one is going to argue with you.

A camel can survive a water loss of about 40% of their body weight and survive a couple of months without water. If humans lose 10% of their body weight in water, they can no longer move, drink or speak. Water can only be administered intravenously. Knowing your threshold to pain and limitations will enable you to ensure that you create a contingency fund that is large enough to be practicable in an emergency but small enough so that it’s not tied up unnecessarily instead of helping you to grow your wealth.

How To Get Your Contingency Fund Started Today
“The individual most accountable for your future financial welfare, is the one you see in the mirror today.” – Kemberly Wardlaw

If your already thinking that your barely surviving as it is to make ends meet, maybe your overwhelmed with mounting debt or have a hundred things that you want to do with your money. Before you start thinking that it’s impossible consider this from Mohammed Ali who said, “Impossible is just a big word thrown around by small men who find it easier to live in the world they’ve been given than to explore the power they have to change it. Impossible is not a fact. It’s an opinion. Impossible is not a declaration. It’s a dare. Impossible is potential. Impossible is temporary. Impossible is nothing.”

No matter where you are financially, you can get this contingency fund started today. All you have to do is make the decision and the commitment to make it work. The rest as they say is just details.

The first step to getting started is decide on a place to park your money which is out of reach for day to day expenses and needs. You want to stop yourself from getting easy access to it so a sensible place is to park it in a high interest savings account. The idea is that the account should not give you an access card or cheque book which can tempt you to use the funds frivolously. An ING savings account is a good place to start or any other type of account which is liquid enough for you to access your funds in a relative short period of time when the need arises. Term deposits or any other type of account which locks your money away for a fixed period of time is not a great solution nor is anything that has an element of risk such as managed funds.

The second step is to make this automatic. If you leave it to your own devices then your likely to never find the money to deposit into your contingency fund. You want to setup an automatic direct deduction which you can either setup with online banking these days or call your bank to get this organized. What you want is for a portion of your money to be withdrawn from your everyday savings account each time you receive your paycheck and for it to go directly to your contingency fund account. This way you never see the money and trust me, you wont even miss it. You just find ways to live on what is left in your savings and you will find that there is no real noticeable difference in your current lifestyle.

The third and final step is to set a target to know when to stop once it is reached so that you can start saving to invest the money better or accelerate your debt reduction plan. You want to try and accumulate your contingency fund as efficiently as you can so setting aside $100 or whatever you can spare will enable to reach your goal.

Popularity: 11% [?]

If you're new here, this site is dedicated to inspiring, motivating and encouraging anyone who is young at heart to live a life of significance filled with peace, joy, and success. If you enjoy your stay consider Subscribing to my Feed or Subscribe Via Email. Thanks for visiting!

Posted in Personal Finance