The thing about emergencies is that we never expect them to happen to us. But sure enough, the fridge stops working, we get a flat tire, we get injured, we lose our job suddenly, a friend or family member urgently needs our assistance, there’s a flood or fire, and on and on. Sometimes the unexpected costs are more positive – you are promoted at work and need to get some suits, or you are introduced to an opportunity to invest in a safe, high return deal. Having extra cash to deal with the tragedies as well as take advantage of the opportunities is a good idea all around and one way to make this happen is to get into the habit of squirreling some money away each time we get paid. A good rule of thumb is 10% of your take home income.
The main purpose of an emergency fund is to have money in place so that if there is ever an emergency, you are able to cover your daily expenses as well as deal with the extra out-of-pocket cost. Each person’s emergency fund will be different, depending on their needs, wants, and lifestyle, but there are some core ingredients that should be in every emergency fund.
Your emergency fund needs to be easily accessible or liquid, and ideally earning you some interest as well in a safe investment vehicle, as you never know when you may need to use the funds. Most banks offer 0 – 1% for ‘high interest’ savings accounts – RBC’s high interest e-savings account is currently paying .75% and ING Direct is currently paying 1.2%. (The best high interest deal we are aware of and currently participate in at Share the Wealth pays 12% per annum. Call or email us for more information – info@sharethewealth.ca). The Tax Free Savings Account is also sold by banks as a good place for GIC’s and savings accounts paying 1-3% interest, but don’t be fooled. Leave available space in your TFSA for higher performing investments that will actually benefit you tax-wise. You can read one of our previous blogs for ideas on how to best use your TFSA.
I’m often asked how much money should be set-aside in an emergency fund. The typical answer to this question is between 6 to 9 months worth of living expenses, which I believe to be a safe estimate. Keep in mind that your living expenses may also change during an emergency situation, meaning they may go up or down depending on the type. For example, if the emergency puts you in the hospital, and you require private treatments that may not be fully covered by medical (physiotherapy, counseling) then your expenses will go up. If your emergency is losing a job, your expenses may go down if you choose to live a more frugal life ie. Saving on gas, lunches out (if you are still doing that after reading our Success Key blog post!), while you get back on your feet.
If the emergency is an unexpected positive event, you will have the cash to take advantage of it and enjoy it! When this happens you can then replenish your emergency fund back up again by saving 10% until you have your 6-9 month contingency fund in place again. **Note: This can be a slippery slope for those struggling with over-spending or rationalizing their negative spending habits – be honest with yourself on what is an ‘unexpected positive emergency’ and what isn’t.
Don’t forget that Insurance policies could also be part of your emergency strategy and many financial experts recommend this. For example, a mix of disability/critical illness, life and home/contents insurance can lower your risk levels as they will cover you should you need them.
Too often, emergency funds are not thought of until it’s too late, but by planning for the unexpected in advance, a lot of stress will be alleviated from the negative situations and you will also be prepared for the positive ones too!
Disclaimer: This blog should be used for informational purposes only and should not replace the advice of a licensed financial professional.
Great Post Jayn.
I totally agree. With a good “emergency fund” many of the examples that you listed such as a broken fridge, flat tire etc would pass as inconveniences rather than emergencies. If we don’t have to run out and slap a new fridge on a credit card, then we don’t have to experience the stress of figuring out how we are going to pay for this unexpected expense that has now added to our debt servicing ratio.
I also appreciated you calling those “high interest” 0.75% savings accounts exactly what they are: a money making machine for the big banks. It made me think of a related but different trick that I am aware of, and quite frankly refuse to participate in, are those commercial gift cards. For example, consider Starbucks cards; it may seem like a good idea. Placing $20 on a card for convenient use if one were to frequent Starbucks. What people don’t realize is that globally people are giving Starbucks millions of dollars interest free to do with as they will.Shocking when you think of it that way isn’t it? I for one am keeping my money in my pocket and out of the hands of major corporations and the big banks.
[...] The ‘What If’ Account: Sometimes the worst does become reality – it is possible that you may be out of work for a long period of time, and you will have exhausted the money in your business account as well. The ‘What If’ account comes in handy at that time. You may also find it useful in the case of a car breakdown or a dental surgery, for instance. This account serves a similar purpose to the personal emergency fund. [...]