Keep a contingency fund handy for emergencies

Here is the edited transcript of the interview on CNBC-TV18.

Q: How important is a contingency fund and is there any standard that pegs the ideal amount one should invest keeping in mind their salary?

A: It is important. In fact contingency fund should be the first step before you get into wealth creation. That is the liquid money which comes handy. Let me give you an example, during the July 26 downpour in Mumbai, a couple of years ago, phone lines were not functioning and ATMs were not working.

People could have had crores of rupees worth of assets, but no liquid money. That is where you are in trouble. You need to have contingency fund. In terms of what kind of reserve that you should have, it should ideally be equivalent to about three months of mandatory expenses.

Keep aside about three months of reserve. If you are retired, it maybe six months and if your income is volatile, it maybe for a little longer. But, usually for a standard middle class Indian family, about three months mandatory expenses should be kept for the contingency fund. Keep about 15-20 days of money in cash form at home and the rest could be in savings bank account linked to FD with an ATM facility.

Q: So you hold the balance money in a savings account which is withdrawable through an ATM. That's what you mean or would it be easily liquefiable bank FDs?

A: We now have savings accounts which are linked to fixed deposits. So you put your money in savings accounts, but banks transfer it into FD and whenever you want to withdraw money you can do it. If the savings account does not have sufficient balance, automatically the FD would be broken and you will get your money.

So instead of just leaving it idle in savings bank account at 4 percent interest, you would rather keep it in fixed deposit linked accounts. Even if it is midnight and you require the money, you do not have to follow any procedure to break that FD. They call it two in one account or transfer account.

Q: An investor and his wife are professionals with no dependents. They cumulatively hold around Rs 8 lakh in Sensex related stocks and mutual funds. They are sufficiently covered with term insurance policies and also have health insurance plans. Investor's question is do they still require to keep a contingency fund or can their insurance policies and reasonably liquid investments take care of their needs?

A: No, you still need to keep a contingency fund. As I gave you an example of the July 26 downpour, if there is a terrorist attack or if there is a tsunami, you require money to buy vegetables, milk or basic grocery, for healthcare requirements. Neither your stocks will be useful, nor your mediclaim policy would be useful. Moreover, if it is a Friday or a Saturday night then you have to wait till Monday-Tuesday. You will need to have three months mandatory reserves in the form of contingency irrespective of the size of assets that you have.