As we move into 2023, having a contingency fund is more important than ever. With the ever-changing economy, it’s important to have a safety net of funds in case of an emergency or unexpected expense. Having this money saved up can provide peace of mind and security for you and your family. In this blog post, we’ll discuss why having a contingency fund is so important and how you can start one today!
What Is A Contingency Fund?
A personal contingency fund is a financial cushion that can be used in the event of an unexpected expense or financial emergency. It is a type of emergency fund that is kept separate from your regular savings and investments, and can be used to cover expenses such as medical bills, car repairs, or home repairs. It is important to have a personal contingency fund to help you stay afloat during difficult times, and to help you avoid going into debt. This is just one important element of family finance planning.
When creating a personal contingency fund, you should aim to save a certain amount of money that you can comfortably afford to set aside each month. This amount will vary depending on your income, expenses, and lifestyle. As a general rule of thumb, it is recommended to save an amount that is equivalent to three to six months of your living expenses. This amount will give you a substantial financial cushion to fall back on should an emergency arise.
When establishing your personal contingency fund, it is important to choose a safe and secure place to store your savings. High-yield savings accounts, money market accounts, and certificate of deposit (CD) accounts are all good options. Each of these accounts offers different levels of liquidity and interest rates, so you will need to research the different options to determine which account best suits your needs.
Having a personal contingency fund can help you to stay on top of your finances and provide peace of mind in the event of an unexpected expense or financial emergency. It is important to save regularly for your personal contingency fund in order to ensure that you have the financial resources to cover unexpected expenses.
What Does Contingency Mean?
Contingency is a term used to describe an event or situation that may occur in the future. It can be used to describe a potential outcome, such as when making investments. By understanding what contingency means and how it applies to personal finance, individuals can better prepare themselves for potential opportunities and risks associated with their financial decisions.
How A Contingency Fund Can Help You
A personal contingency fund is a savings account that is set aside specifically for unexpected and unplanned expenses. It is meant to provide financial security and act as a back-up plan for any emergencies that may arise, these emergencies could include the following;
1. Medical Expenses: Unexpected medical bills, insurance deductibles, and prescription costs can be covered by a personal contingency fund. This fund can also help if you need to travel for medical treatment or if you need to pay for specialist care.
2. Home Repairs: Unexpected home repairs such as roof repairs, plumbing problems, and appliance replacements can put a strain on your budget. A personal contingency fund can help cover these costs.
3. Car Repairs: Unexpected car repairs can be costly and can be covered by a personal contingency fund. This includes repairs such as replacing a broken transmission, fixing a flat tire, or replacing a broken alternator.
4. Job Loss: Unexpected job loss can put a strain on your finances. A personal contingency fund can help cover your living expenses while you search for a new job.
5. Natural Disasters: Natural disasters can cause major damage to your home and property. A personal contingency fund can help cover the cost of repairs and replacement of damaged items.
6. Pet Expenses: Pet owners know that unanticipated pet costs can add up quickly. A personal contingency fund can help cover unexpected pet expenses such as veterinary bills, pet food, and grooming costs.
7. Education Expenses: Unexpected education expenses such as tuition hikes, textbook costs, and lab fees can be covered by a personal contingency fund.
8. Legal Expenses: Unexpected legal expenses such as lawyer fees, court costs, and filing fees can be covered by a personal contingency fund.
9. Family Emergencies: Unexpected family emergencies such as funerals, weddings, and family reunions can put a strain on your budget. A personal contingency fund can help cover these costs.
Savings Statistics
There are some interesting and also concerning statistics about savers in the US. As at June 2022, the monthly personal saving rate in the United States amounted to just 5.1 percent. This is the ratio of personal saving to disposable personal income.
Less than half of Americans could cover a surprise 1,000 U.S. dollar expense from their savings, according to a January 2022 survey by statistics agency Statista. According to a survey conducted among employees in the U.S. in 2022, a fifth reported that they would only be able to afford an out-of-pocket expense of 500 dollars or less for an unexpected illness or injury.
But data shows that in 2021, 88% of American employees faced an unexpected expense, most often medical related, underlining the importance of having in place contingency funds for emergencies. The graph below highlights the most common health related unexpected costs in 2020 and 2021.
Find more statistics at Statista
Benefits Of Contingency Funds For Emergencies
1. Financial Security: It can provide a source of funds to cover unexpected costs, such as medical bills, car repairs, or a home repair. Having a reserve of funds to turn to for these types of unanticipated expenses can provide peace of mind.
2. Emergency Preparedness: Having a personal contingency fund can help you prepare for a potential emergency. For example, if an unexpected job loss or other financial emergency arises, you’ll have a reserve of funds to rely on until the situation is resolved.
3. Encourages Saving: A personal contingency fund can help to encourage saving behavior, motivating people to save up for a big purchase and help prevent the temptation to spend money unnecessarily.
4. Avoid Bad Debts: Bad debts include things like high interest credit cards and payday loans. These types of debts are what people usually turn to as a last resort when they have no emergency fund in place, but these can often leave borrowers worse off financially. Having a personal contingency fund in place can help you avoid bad debts.
5. Peace of Mind: Knowing that you have a fund to rely on in an emergency can provide you with peace of mind. It can be reassuring to know that you’ll have a source of funds to turn to if something unexpected happens.
Can I Use My Investments As A Contingency Fund?
Yes, it is technically possible to use your investments as a contingency fund. However, it is not recommended for a few reasons.
First, investments can be volatile, meaning their values can go up or down unpredictably. When you need to use your contingency fund, you want to be sure that it will still have enough money to cover the emergency expenses. If your investments have gone down, you may not have enough money available.
Second, when you take money out of your investments, you may be subject to taxation and other fees, which can reduce the amount of money you have available in your contingency fund.
Finally, when you use money from your investments, you may no longer be able to meet your investment goals. For example, if you are investing for retirement, taking money out of your investments may mean you have to save longer or save more to make up for the money you have taken out.
For these reasons, it is not recommended to use your investments as a contingency fund. It is best to keep a separate emergency fund in a savings account or other liquid assets to cover unexpected expenses.
What Are Liquid Assets?
Liquid assets are financial assets that can be quickly converted into cash. Examples of liquid assets include:
- Cash
- Checking account
- Savings account
- Money market account
- Treasury bills
- Certificates of deposit
- U.S. Treasury notes
- Mutual funds
- ETFs
- Stocks
- Short-term bonds
- Commercial paper
- Some precious metals
- Foreign currency
- Banker’s acceptances
- Money market funds
What Are Illiquid Assets?
Illiquid assets refer to investments or assets that cannot be easily converted into cash. They are not easily bought or sold on the market and usually require a longer period of time to convert into cash. Examples of illiquid assets include;
- Real Estate
- Private Equity
- Art
- Collectibles
- Cars
- Antiques
How To Create A Contingency Fund
Creating a contingency fund involves setting aside money in case of an emergency. It is wise to keep the funds in liquid assets, such as checking and savings accounts, certificates of deposit, money market accounts, and short-term bonds, so that they are easily accessible when you need them.
When choosing a savings vehicle for your contingency fund, consider the interest rate, fees, and any early withdrawal penalties associated with the account. Also, consider whether you prefer a fixed term product with a higher interest rate or a more flexible product with a lower interest rate.
Checking and savings accounts are great for liquidity, but the interest rates are usually quite low. Certificates of deposit (CDs) and money market accounts offer higher interest rates than checking and savings, but the funds are not as easily accessible. CDs generally have a fixed term and may have early withdrawal penalties, while money market accounts are more flexible and have higher interest rates.
Short-term bonds may also be an option for a contingency fund. These have higher interest rates than CDs and money market accounts, but they are less easily accessible. They also have the potential to lose value if interest rates rise.
Overall, money market accounts are often the most preferred choice for an emergency fund due to the combination of decent interest rates with relatively easy accessibility. However some savers prefer to use fixed term CD accounts. This has the benefit of potentially much higher interest rates but often has an early withdrawal penalty. This can help those that are tempted to spend money to avoid accessing their funds unless it is a true emergency.
Choose the option that best meets your needs and provides the best return for your money.
How Much Should You Save In A Contingency Fund?
It’s often recommended that you have 3–6 months’ worth of living expenses saved in a contingency fund. This can be especially important for individuals who are retired or nearing retirement, as their income is likely to be lower than those in employment.
When deciding how much to save in a contingency fund, consider your current financial situation and your ability to deal with unexpected expenses. If you have enough funds to cover 3–6 months of living expenses, it’s recommended that you save that amount.
For example, if your monthly outgoings on your bills amounts to $1000, then you should aim to have at least $3000 set aside in an emergency fund as a minimum.
If you don’t have enough funds to cover 3–6 months of living expenses, you should start by saving what you can and work your way up to the recommended amount.
It should be noted that these are recommend minimums, you should always aim to save more than this if you can, ideally for up to 1 years worth of expenses. One of the best ways to achieve this is to set up regular payments from your checking account to your savings account to automatically transfer a small, set amount each month. Over time this can really build up into a substantial sum.
Retirees and those nearing retirement may need to have a larger contingency fund than those in employment, as their income is likely to be lower and they may not have access to the same income-earning opportunities. It is recommended to have up to 3 years worth of expenses covered.
Additionally, retirees may be more likely to face unexpected expenses such as medical bills or home repairs, which can be costly. Therefore, it’s important for retirees to save as much as possible in their contingency fund, as it can provide a financial cushion and peace of mind.
In addition to saving for unexpected expenses, retirees should also consider setting aside funds for long-term goals such as travel or a new home. This can help ensure that retirees have enough money to enjoy their retirement years and not worry about running out of funds.
Where To Start An Emergency Fund?
Most banks and credit unions offer a variety of different savings account options that are suitable to create an emergency fund. When selecting a provider you should look for savings offering a high rate of interest that will allow you to earn more on your deposited cash.
However, as accessibility is an important aspect of emergency savings funds, you should also pay careful consideration to any applicable fixed term products with withdrawal periods and early access fees.
Contingency Fund Conclusion
In conclusion, it is important to have a contingency fund in order to be prepared for any unexpected expenses. It is recommended to have at least 3–6 month’s worth of expenses set aside in a savings account, or more if you are retired.
Your fund should be made up of highly liquid assets, these being assets that can easily be converted to cash. Cash savings accounts are usually the best option, with most being easily accessible such as a money market account. Having this fund set aside will help you stay on top of your finances and provide peace of mind during difficult times.
