What if you’re caught in a situation that puts you in urgent need of cash? How would you deal with cash crunches or unfortunate circumstances such as the loss of employment?
Building an emergency fund can provide a solid foundation for your long-term financial plan and give you savings to fall back on during a financial or medical emergency. Your future self will definitely thank you for having an emergency fund in place.
According to a 2019 BMO poll, just 36% of Canadians who have long-term savings are setting money aside in an emergency fund, and one in four feel the amount in that fund is insufficient. If you count yourself among this cohort of underprepared Canadians, take heart.
If you are looking for some help planning an emergency fund, here is a handy guide to get you started.
What is an Emergency Fund?
An emergency fund is your financial cushion that will help you through any rainy days in life. If there ever comes a time when you need some money on short notice, your emergency fund is your saviour. In other words, these savings are off limits to you unless you encounter a genuine emergency, such as:
- a job loss,
- accident,
- property damage, or
- long-term illness.
What qualifies as an emergency fund?
Simply put, an emergency fund is an aggregated sum of money that is set aside to handle unforeseen expenses such as a medical emergency or home repair. Believe us when we say this, having an emergency fund can make a world of difference to your finances.
Benefits of an Emergency Fund
Financial security keeps stress at bay. An emergency fund is your financial safety net and prepares you for anything life may throw at you:
- It helps you to avoid spending on a whim.
- You can say goodbye to borrowing.
- Something is always better than nothing.
How Much to Save in an Emergency Fund
Deciding how much to save for emergency purposes depends in part on your monthly expenses, your work, and how much (and the type of) debt you have.
Expenses: If your monthly expenses are quite low—say, if you’ve paid off your mortgage or are living rent-free with your parents—you might not need a very big emergency fund. That’s because you’ll want to save enough to cover at least three-months’ (and up to a year’s) worth of expenses if you can’t work.
Type of work: Some people work in fields or positions that are in demand and may not have much difficulty finding a new job at a similar income if they got laid off. Others, however, might be in a field with more available workers than jobs. They would be wise to plan for a longer stint of unemployment and, therefore, accumulate a larger emergency fund.
Debt: Those who are carrying a lot of high-interest debt, such as credit card debt, might be better served by paying down that debt before accumulating savings in an emergency fund. In that case, however, as soon as the debt is paid off, the money that went toward servicing and paying down debt can be channelled into an emergency fund.
Also of note, if you have a personal loan or mortgage, try exploring credit insurance. It could cover your debt payments during an emergency.
How to Build an Emergency Fund
As any personal financial planning expert will tell you, the best way to save money is to pay yourself first. What this means is that as soon as you receive your paycheque, you take a predetermined amount off the top and deposit it into your emergency fund account. You can even set up automated transfers to simplify matters.
But, how will you know much you can you afford to transfer into savings? For this, you need to create a budget so you can see exactly where your money is going. Look at how much you are spending on needs (housing, groceries, transportation, etc.) and how much on wants (entertainment, vacations, eating out, etc.) to see where you might be able to cut back. You can then transfer more to your emergency fund, or pay off debt, as necessary.
As previously mentioned, if you are in debt, getting out of debt should be the priority for you. Once you’ve paid off your debt, redirect those monthly payments to the emergency fund.
Finally, if you feel you cannot possibly cut out any expenditures from your budget to save more, you can try to increase your income through a side hustle, selling items you no longer use, starting a home business selling a product you already use and enjoy, or asking your boss for a raise.
Where to Put Your Money to Create an Emergency Fund
Since the nature of an emergency means you likely won’t have any warning before it happens, the money in your rainy-day fund must be easy to access at a moment’s notice. That means it cannot be tied up in any kind of investment that carries risk, because you can’t know what the state of the market will be in when you need to withdraw the funds. If the investment experiences a loss in value right before you need the money, you could be out a bundle.
On the other hand, you don’t want to leave your emergency fund in a traditional chequing or savings account, because you’ll earn little to no interest.
High-interest savings accounts. A number of financial institutions in Canada offer specialized savings accounts that pay out higher levels of interest without exorbitant fees for infrequent withdrawals.
Guaranteed Investment Certificates (GICs). Also called term deposits, GICs offer higher interest rates than savings accounts, if you leave your money invested in the GIC for its entire term. Because you may need access to your emergency funds quickly, go for a shorter term (of 30 or 60 days) that you can roll over when the term ends. If you do choose to invest in GICs, keep at least 30- or 60-days’ worth of savings in a high-interest savings account to tap into first, so you won’t need to withdraw money from the GIC early.
Tax-free savings accounts (TFSAs). A TFSA is like a bucket where you can put savings or investment accounts and shelter the earnings from tax. Your savings will earn interest tax-free, meaning you won’t have to pay any income tax on the interest income, as you would with a non-registered account. Just make sure to stick to low-risk investments, such as GICs or high-interest savings accounts, within your TFSA since you may need to cash out quickly.
Leverage Technology with Money-Saving Apps
In a previous blog post, we covered some great budgeting apps to help you get your finances in order. Here are a few other must-have apps that will help you discover special offers, enjoy the best product prices in town, and much more:
- Caddle and Checkout51 is a grocery savings/cashback app.
- Ebates offers cashback on purchases with a variety of retailers.
- Swagbucks cash app for shopping, watching videos, paid surveys and more.
- GasBuddy helps you find the cheapest gas in your area.
- Drop helps you earn free gift cards at popular retailers (McDonald's, Walmart, etc).
- VarageSale is extremely useful when you want to sell items online.
- ShopBot is great when you want to compare prices on products to ensure you’re getting the best deal.
When Should You Dip into Your Emergency Fund?
It is important for you to know the distinction when it comes to what constitutes an emergency or an unexpected expense. Not every large expense is a good enough reason to dip into your emergency fund.
Nevertheless, don’t think twice during times of need. Even if a situation arises where your emergency fund is drained, just stop, re-evaluate, and start building your emergency fund again.
You’re Not Alone
If you need help starting an emergency fund, or if an emergency has already occurred and you need to borrow, please contact us to get started.