Personal Finance and Professional Management Fundamentals

June 18, 2007

While Planning For Educational Expenses, Tackle Emergencies

While planning for educational expenses, make sure you set aside some amount to tackle emergencies. Here we highlight the need for a contingency fund.

With education expenses increasing over the years, a lot of advance planning is required to ensure that adequate sums of money are available to complete one’s course when required. Most people consider the funds that are required for fees and other expenses over the time period of the course and then provide for such funds. However, one must also set aside an additional sum to tackle any emergencies that may arise. Such emergency costs cannot be planned for. But care should be taken to ensure that a large part of the total expenses is not classified as emergency costs because this reflects poor planning.

As regards the basic expenses, fees have to be paid at the beginning of each financial year or as specified by the institution. Also, books have to be bought during a certain time period. Since these expenses are spaced out over various time periods, they reduce the burden on the individual. However, such a luxury is not possible in the case of a contingency fund. There is no surety as to when the need for such a fund may arise and hence, the fund has to be ready for use from the day of start of the education.

Once such a contingency fund has been created, one needs to decide the amount that has to be kept in it. If only a small amount is set aside in this fund, one may have to run around at the last minute for additional funds. This was the case recently when students appearing for their CFA exam had to bear the cost of flying to a neighboring country, as well as acquiring a visa, in order to sit for their exam.

While the amount set aside in the contingency fund should not be too small, it should not be too large either, as this will result in a huge sum being locked-in. There are no rules for this, but one way is to consider the contingency amount as a certain percentage of the actual cost of the educational course. This may be 5% or 7% or even 10% of the total fees; the figure depends upon one’s judgment of the expenses that may crop up.

Once the amount is fixed, one should ensure that this figure is invested in the right manner so that it can be used when required. Keeping this amount in a savings account is not a good idea because it will not earn much return. At the same time, this amount has to be invested in a place from where it can be withdrawn quickly if required.

Hence, two options are available for an investor. The first option is a simple fixed deposit with a bank where there is no lock-in. The other option is any liquid scheme of a mutual fund. Here, the growth option that generates capital gains is a better route, even though this results in a slightly larger tax impact. The higher tax blow is not a deterrent because the main reason for investing the money here is not to earn higher returns, but to earn some return while the money is lying around, waiting to be used in case of an emergency.

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