So you’ve paid off all your debt and want to start to build your savings and investments? Before you start working on building up your RRSP, your first savings priority should be an emergency fund. If you want to protect yourself in the even of financial setbacks, it’s a good idea to have an emergency fund that works for you. From paying a high deductible on your insurance policy, to providing you with a way to pay bills if your hours at work are cut, an emergency fund can be very helpful.
I’ve mentioned previously that I don’t believe an emergency fund makes much sense if you still have debt. By paying down debt on a credit card or credit line, you then free up that balance, which could be re-borrowed in the event of an emergency.
At the same time, paying down your debt, especially if it is high-interest debt, allows you to stop wasting money on interest payments. The longer you are in debt, the less money you have to build up your own wealth. One of the best things you can do for yourself is to get rid of high-interest debt as soon as possible. Once that is done, it’s time to build an emergency fund.
What Is an Emergency Fund?
An emergency fund is a reserve of cash that you set aside for unexpected expenses. This usually applies to things that break: your car, your appliances, your furnace or other items in your home – or maybe even an arm or leg. (Sometimes you have to pay for certain types of casts or splints.)
You may also want to build an emergency fund to cover higher future mortgage costs. If you are on a variable rate, you may want to have a cushion in case rates rise. If you have a very low fixed rate mortgage, you may have to renew at a higher rate later. It pays to use a mortgage calculator ahead of time to make sure you’ll be able to cover your new payments.
Why Should I Have an Emergency Fund?
An emergency fund can give you peace of mind and keep you from incurring debt and the extra costs that come with it. You will avoid both stress and interest.
Should I Pay Down Debt or Build an Emergency Fund First?
There is some debate on this issue, but I come down on the side that says you should have at least a minimum emergency fund of $500 – $1000 before you attack your debt. This will keep you from incurring more debt if your dishwasher breaks down or you blow a tire.
If you know your washer and dryer are on their last legs, you may want to save enough to cover a new set. (See my article on Preemptive Purchases.) If your car is likely going to need brakes over the next year, you can save for that in advance too. Once you have paid down your consumer debt, I would suggest padding your emergency fund to protect against job loss.
How Much Should I Save in My Emergency Fund?
Again, there’s a lot of debate over how much you should save. In the end, it’s your call. Once you have saved the minimum amount ($500 – $1000) and paid down your consumer debt, the exact amount you need to save depends on your situation.
If you have a very stable income, you may only want to save enough to cover expenses for a month or two. If your income is variable or you are worried about losing your job, you may want to build up a 6-month cushion, or even more if it helps you sleep at night.
Is your home due for a new roof? What is the life expectancy of your vehicles and appliances? How accident/illness prone are your kids? If you have young children who tend to get sick frequently, you can incur elevated costs for prescriptions and/or over-the-counter medications.
Obviously, you can’t predict every possible expense. That’s sort of the point of the emergency fund. But you can arrive at a better ballpark figure if you have a good handle on what might go wrong. Every year when I set up our budget, I ask my husband for rough figures on car care and home maintenance expenses and then I budget a little above that just in case.
Where Should I Keep My Emergency Fund?
Your emergency fund needs to be easily accessible. We basically have two emergency funds. We keep the largest portion in a high-interest savings account. We also keep a cash cushion on hand at home in case we can’t make it to the ATM (or the ATMs are down) or we just need some cash for unexpected expenses like field trips or fundraising for the kids’ schools. I track this cash and it gets replaced as soon as possible.
We’ve held a number of garage sales over the years and I usually use the proceeds of those for the cash portion of our emergency fund. It helps to keep some smaller bills, loonies, and toonies on hand from these sales for school expenses like those mentioned above. (Exact change is often required.) I can’t tell you how many times I’ve been grateful for our garage sale cash box when I’m rooting around for $3.75 for a hot dog day or some other event.
When Should I Use My Emergency Fund?
Your emergency fund should be reserved for true emergencies. An unexpectedly good deal on a vacation package doesn’t count. If you use your fund for things like that, it won’t be there for you when you really need it. If you’ve been around awhile, you know that Murphy’s Law says that you’ll have a fender bender or some other bit of bad luck right after you’ve booked your cruise.
Set some rules for yourself and follow them. Write them down if you don’t trust yourself or your significant other to stay disciplined. When you want to tap your emergency fund, whip out your list of rules and see if your proposed purchase fits. If it does, go ahead and spend the money. If not, you’re either going to have to do without that item or wait until you’ve saved enough to buy it without debt.
If you need to use some of your emergency fund, take some time to re-evaluate your position afterward. You’ll probably want to take some time to replace that money so that you’ll be ready for the next emergency.
Why an Emergency Fund Matters
If your debts are paid off, an emergency fund acts as a form of insurance. The money is there if you truly need it, without having to go into debt or withdraw from your RRSP.
Most often, emergency funds are described as a safety net in case of job loss. Another good use for an emergency fund would be to use it for your home or auto insurance deductible. Having the money saved in advance gives you the ability to raise your deductible to reduce your insurance premiums. This saves you money on premiums each month — money that you can put into your emergency fund to earn interest.
Building Your Emergency Fund
It’s likely that you’ll need to save up to reach your emergency fund goals, so how much is the minimum you should have in your emergency fund? Rules of thumb suggest that you save up anywhere between 3 and 12 months’ worth of expenses. I think a true bare minimum would be either enough money to cover one month’s expenses or your insurance deductible, whichever is highest. Maybe this is $1,000 for some, while it might be much more for others.
You might have to start small to reach your initial goal, and that’s ok. The important thing is to get in the habit of setting money aside. Put aside as much as you can until you hit your bare minimum. Use a high yield account so that you can make the most out of your interest yields.
From that point, keep adding savings from each pay cheque until you reach an amount you feel comfortable with. Once you have the total amount saved in your emergency fund, you can practically forget about it until the need arises.
8 Ways to Creatively Build an Emergency Fund
Finding money in already tight budgets might feel overwhelming, but with creativity and determination, you can build up your emergency fund before a crisis hits.
1. Set Up a Separate Savings Account
Create a separate account that offers high-interest (perhaps a Tax Free Savings Account) and faithfully put your deposits there. Keeping this fund separate will minimize the temptation to withdraw the money for non-emergencies.
2. Sell Things
3. Start Small
Calculating the thousands of dollars to put in an emergency fund can be overwhelming. But tucking away an extra $20 or $30 here and there will absolutely add up over time.
4. Save Your Change
For a season, make a rule that you won’t spend any coins. Tuck them in a jar and deposit them towards your emergency fund once a month.
5. Treat It Like a Bill
Every month we receive bills for utilities, property tax, mortgage payments etc. These have to be paid on time, without thought. Send yourself an emergency fund bill each month, and pay that faithfully. Another option is to set up an automatic withdrawal, so the money comes out regularly.
6. Spend Less
I love the Duggar family’s saying: “Buy used and save the difference.” Challenge yourself to spend less in at least one budget category, and direct the money you saved towards your emergency fund. If you typically spend $600 on groceries, but you use price matching, meal planning and coupons to get that down to $400, you will have $200 to tuck away. I also love doing this with air miles cash. If I buy $100 in gas with Air Miles, I can put the money I saved towards an emergency fund.
7. Make More
Money is mathematical not magical. To fund an emergency fund creatively you either need to spend less, or make more (or both). Brainstorm ways to make more. Can you ask for a raise? Take on an extra part-time job? Think outside the box with friends who inspire you. Perhaps freelance your skills as an editor, writer, photographer – the sky is really the limit.
8. Find Inspiration
There are many amazing stories on the internet explaining how people choose to live frugally to pay down debt and create an emergency fund. If your focus waivers or you feel discouraged, spend some time looking for inspiration.
Tips to Build a Better Emergency Fund
1. Start Small
Many of us feel overwhelmed when we listen to experts who tell us that we need nine months’ worth of expenses saved up. If your expenses total $3,000 a month, that’s $27,000 you need! Focusing on big numbers like that can be discouraging, and lead you to not set anything aside at all.
Instead, start small. Focus on what is doable right now, rather than the end result. Go through your budget, and determine how much you can set aside right now. Once you’ve done that, start putting it in an account. My wife and I both use the Tangerine TFSA, and you can get 2.4% interest for 6 months and up to $50 in bonuses through this link. Then consider ways you can increase what you set aside until you reach your goal.
2. Consider Accessibility
Your next step is to consider accessibility. You want to be able to get to your money when you need it. Tying it up in an investment account can be problematic, especially if you run into a true emergency that requires that you get your cash quickly. Sometimes, this means that you give up some of your return so that you can get to your money quickly. An account connected to an ATM card, or an account that is linked directly to a checking account with debit access, are good choices if you want immediate accessibility.
It’s also possible to consider different types of emergency setups. You can keep part of your fund in an immediately accessible account, and then keep the bulk of it in an account that is a little harder to get to, but offers better returns. For instance, you can keep a smaller amount in the local bank, where you can use it immediately while you wait for a larger amount to be transferred from an investment account after you sell some assets.
3. Look for High Yield and Other Benefits
Now that you know which accounts are quickly accessible, it’s time to try and get the highest possible return that you can. Unfortunately, savings accounts are known for low yields. When you have money that is basically safe, and easily accessible, it’s not going to pay you a very high yield. You can turn to high yield accounts to help ease some of the pain, by giving you the best possible return for your money.
If you are building an emergency fund portfolio, with different types of accounts, you can create a GIC ladder for better yields. You can also consider a TSFA, which comes with tax benefits, as well as the possibility of better returns.
Make Sure You Can Access Your Money When Needed
You want to be able to get your money out quickly in the event of an emergency, so make sure that the money is in an accessible account. A high interest savings account would be a good choice, possibly within a TFSA if you have available contribution room. However, it’s important not to have this money too accessible. A debit card linked to your emergency fund is usually not the best idea.
Keep in mind that this account is for true emergencies, not for a car, vacation or Boxing Day deal. Of course, now that you have an emergency fund, you can now start saving in separate accounts for these items as well!
Start Your Emergency Fund Today
The best time to start was yesterday. The next best time is now.
That’s one of my favourite quotes and it definitely applies here. Sure, you should have an emergency fund, and you may have even regretted not starting one yet. So why not start today? With a $100 deposit, you can get started with Tangerine and setup automatic savings with them. As a perk for taking action, you can get $50 in bonuses and a 2.4% interest rate, so open an account and protect yourself from financial disaster.