An emergency fund is an essential part of any budget. Without one, the best laid financial plans can be easily derailed, and you could quickly end up with financial problems. And yet 44% of Canadians have inadequate or zero emergency savings.
So, why is having an emergency fund so important? How much in emergency funds should you save? And what are the quickest ways to build up emergency fund savings?
Why an emergency fund is so important
The best budgets account for every dollar that you have coming in. Whether that money is for monthly expenses, mortgage or rent, savings or discretionary spending (the fun stuff), all your income should be accounted for.
So, what happens if your car breaks down? Or the roof caves in? Or you get sick and can’t work? All of a sudden, you’re going to need extra money, and fast. Of course, most people could put the expenses on a credit card or take out a loan to cover them, but that would have a major negative impact on your budget.
You would need to repay the money you’ve borrowed, and even if you do that in instalments, you’d still have to find that money from somewhere. Assuming you’re going to continue to pay your monthly and housing expenses, the money will have to come from either your savings allocation, or your discretionary spending (or a combination of the two).
This could set your savings goals back considerably. For every dollar you don’t save you’ll also lose out on the compound interest that it would have earned over the next several decades. Reducing your savings input to pay for emergencies could even delay your retirement.
An emergency fund provides you with the emergency money you need to cover any eventualities, so that your savings goals stay on course. Saving for a rainy day doesn’t just help you now: it helps your future self as well.
How much of an emergency fund should you save?
Opinions differ on exactly how much money you should have in your emergency fund, but many agree that it should ideally be between three to six months’ worth of household expenses.
To calculate your monthly expenses, add up the following:
- Housing costs (mortgage/rent, heat, hydro, insurance and property tax)
- Phone and internet
- Transport costs (car payments, insurance, gas, transit)
- Groceries
- Monthly debt commitments (loans, credit card payments, etc.)
The total amount, when multiplied by six or even three months, can be in the tens of thousands. This can be a daunting amount, especially for someone who struggles to save at the best of times.
It makes sense, therefore, to start off small. Even saving as little as $500 could cover many unexpected expenses, such as car repairs or the need for a new appliance. Once you’ve reached the $500 mark, continue to contribute to your emergency fund until it reaches six-months’ worth of expenses. Once you get there, you can divert those savings into your retirement fund.
How to save for an emergency fund
You can get your emergency fund savings off the ground by contributing any windfalls you might receive, including:
- A tax refund
- Any work bonuses
- An inheritance
While these can all give your emergency fund a boost, you’ll also need to contribute to it regularly to get it to the optimal level required for keeping your budget on track.
One of the best tips for saving money for an emergency fund is to make it effortless. Set up a preauthorized payment from your current account to your emergency savings account, on the day that you’re paid. This will ensure that you’ll save the required amount, every paycheque, and will never be tempted to spend it instead.
What you’ve never had you won’t miss, and you will soon learn to manage on less. You’ll be amazed at how quickly your emergency savings will grow using this technique.
Where to keep your emergency fund
Under the mattress is never a good option, but then again, neither is a chequing account. You’ll want an account that delivers a decent amount of interest, while still allowing for easy access, so you can get your hands on the money at short notice. Remember that you might end up keeping a considerable amount of this money for several years, so you need to balance returns with accessibility.
Here are a few tips for saving account options:
- High interest savings account: you’ll get slightly better rates than a chequing account, with similar accessibility.
- GICs: these also offer better rates, but you may have to pay a penalty to take out your money. Consider short-term or redeemable GICs to avoid this.
- Money market funds: you’ll get competitive yields, but it could take some time to withdraw the cash.
Help with starting up your emergency fund
Financial help is available: you don’t have to do all of this alone. An IG advisor can help you create a solid financial plan that will include building an emergency fund. If you don’t have an advisor, you can find one here.
Written and published by IG Wealth Management as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an IG Wealth Management Consultant.
