No one enjoys spending their time contemplating what could happen if they went broke. But if (really, when) an emergency occurs and you’re not financially prepared, the fallout is not only nerve-wracking but can have serious financial repercussions. This is why you need an emergency fund to make a difficult future situation a little easier.
What Exactly is an Emergency Fund?
Also known as a contingency or fallback fund, an emergency fund is a stash of money set aside to cover unexpected life events.
Reasons Why You Need an Emergency Fund Account
Life happens. We’ve all experienced things we never thought we would. When life throws an unwelcome financial surprise your way, you may find yourself in an awkward spot. Think about it. What would you have to do to cover an unexpected $1,000 or $2,000 expense right now? Would you have the funds to cover it, or would you have to somehow come up with it? Two-thirds of Canadians have a rainy day fund sufficient to cover 3 months’ worth of expenses.
That’s great, but it means that one-third of us are living life on the “financial” edge—hopeful of getting by without running into a crisis. Apparently, convincing people to save up for something that may never happen can be a tough sell. Canadians without a safety net live paycheck to paycheck, with many relying on payday loans, credit cards and other high-interest options when in a bind. Getting into debt can be easy (and often fun), but it can be painfully difficult to break out of a debt cycle.
If they only had an emergency fund account, right?
From a purely financial standpoint, you can probably see why having an emergency fund would be helpful. It’s like a soft landing place that can be the difference between a minor bump in your financial journey and an absolute disaster in your entire life. An unplanned expense threatens your financial well-being and peace of mind. An emergency fund account allows you to cover small and big unforeseen life events without going into debt. It helps keep your stress level down by giving you confidence that you can weather most crises.
What are Some of the Top Emergencies People Face?
Murphy’s law is an adage that states, “Anything that can go wrong will go wrong.” And, when it does, you’ll probably need money to fix it. You probably don’t plan on experiencing a medical emergency or getting a flat tire anytime soon. Most people don’t: That’s why they’re called unplanned expenses and why it’s so easy for them to wreck your financial progress!
That said, let’s have a look at the situations in which you’d want to use the money.
Protect Against A Loss Of Income
Protecting your business or career is one of the main reasons you need an emergency fund account. If 2020 and Covid-19 have taught us something, it’s that anything can happen! Even when the economy is doing fine, your business can crash in the twinkling of an eye. If you’re laid off from your job unexpectedly, the money will stop flowing in. An emergency fund will help you to make ends meet. You will be able to pay for food, rent, transport, healthcare, utilities and other day-to-day expenses as you focus on finding the next job. The right one, I might add. You see, if you’re financially desperate, the pressure may force you to take the first position that comes your way, even if it’s not the best fit.
Unplanned Travel Expenses
Imagine waking up to the news that your mom, who lives far away in another province or country, is seriously sick and wants to see you. Since it’s urgent, you may need to catch a last-minute flight, which costs money. You don’t want to use your credit card for such a costly trip that will just rack up interest and increase your debt. If you have enough money in your emergency fund account, it will take some of the financial stings out of dealing with such an expense
Unexpected Home Repairs
It’s raining outside at night, and you’re curled up on your favourite couch catching up on the latest episode of your favourite TV series. Suddenly, you notice that the roof in the living room is leaking. Perfect! Besides ruining your evening plans, a leaking roof could break set you back hundreds of dollars since fixing a leaking roof isn’t cheap. One full roof restoration and you could be eating Ramen instant noodles for the next couple of weeks. Unless, of course, your emergency fund account is loaded! While having homeowner’s insurance can cover some expenses, you may need to come up with some cash to cover the cost if you have a high deductible. Also, your provider may be slow to pay. It’s not just leaking roofs and ceilings. Walls crack, plumbing systems break down and windows get damaged. These are all emergency repairs that you can’t plan for. But you can plan financially by ensuring you have a fund set aside for such unexpected home repairs.
Having a car can be very convenient, especially if you don’t have access to public transportation. But like most machines, your car won’t announce it before it breaks down! There are precious few of us who have not undergone that moment of desperate hope when your mechanic is about to tell you why the engine light is on. If your car breaks down and you don’t have money to repair or replace the defective parts, you may have to default to an Uber or Lyft to make it to work on time. This could quickly become expensive. Even if your vehicle is insured, you may still be required to pay the deductible when you’re involved in an accident. Common repairs like new spark plugs, a timing belt or brakes don’t come cheap.
Don’t get caught off guard like this. An emergency fund account can help you cover the cost of an accident or expensive car repair.
How Much Should You Be Saving for an Emergency?
So how much cash should you keep in reserves?
The actual amount may vary depending on your financial situation. Do you have debt? Try to set aside as much money as you can within your budget, factoring in debt repayment. If you have a reliable job and a steady flow of income, a 3-month emergency fund can meet your needs. You may want a larger (6 months or more) cash reserve if you have an irregular income. You’ve probably seen $10,000 thrown around as a good target amount. But with the rising cost of living, even $10,000 might not be enough to cushion you in the event of a true emergency. The national average monthly cost of living for a single person is estimated at $2,730 and $5,158 for a family of 4.
A good rule of thumb is to have 3-6 months of income saved for emergencies. The number you use to calculate your 3-6 months would include essential expenses. If you were to lose your main source of income, your spending would be (at least it should be) different from what it is when you have a job. So there’s no need to include expenses like entertainment, meal outs, vacations, or even saving for retirement.
How to Set Up an Emergency Fund
Of course, saving 3-6 months’ worth of living expenses is no easy feat. It won’t happen overnight. You don’t have to accumulate all the money at once or give yourself too much time. Instead, set a reasonable time frame to get the number.
Let’s say your bare-bones expenses are $2,000 a month. Calculate the $2,000 by the number of months you need to save for, such as 3-6 months. This means that you will need to save $6,000-$12,000 in your emergency savings account to cover your living expenses. Let’s go with 6 months. If you saved $400 a month in your bank account, it would take two and half years to reach that number. That’s a realistic timeline as long as you’re dedicated to saving that amount every month.
Remember these are only guidelines and you can adjust as needed.
Pro Tip: Set up an automatic transfer to reach your goal faster. If you’re employed, request your payroll department to be transferring a small part of your wage directly into the emergency fund account.
Where Should You Keep It?
It’s vital to separate your emergency savings from your retirement savings and other savings accounts. Sometimes when you see a couple of commas in your checking account balance, you get a little cocky and a little more reckless.
If your emergency savings are only as far away as your closest debit card, you may be drawn to use the fund for something frivolous like a new iPhone or designer sunglasses—not exactly an emergency. Opening a separate High-Yield Savings Account or Tax-Free Savings Account (TFSA) that you contribute regularly will keep you from spending on a whim. Online banks like Tangerine Savings Account, Motive Financial Savvy Savings Account and EQ Bank’s Savings Plus Account are ideal choices because they offer higher interest rates than most big banks’ savings accounts. The high APR will help to ward off the effect of inflation.
Use our free Canadian savings account comparison tool to choose the best bank account for your needs.
While accessible, you shouldn’t tap into the account for anything except emergencies. If you’re married, ensure your spouse has access to the account and understands the situations in which it should be used. Once you’ve settled a real emergency, build your account back up so that you are prepared for the next unexpected event. Also, adjust your savings contributions annually or whenever your household cash-flow changes.
Feeding Your Emergency Fund Account
Do you feel like you’re tapped out, and there seems to be no extra money to put towards your emergency fund account There are 2 things you can do:
Cut Your Expenses
To keep your expenses down, consider doing the following:
- Make a budget and stick to it
- Negotiate for lower bills and insurance rates
- Drop your expensive consumable habits
- Buy gently used, refurbished or generic
- Cancel unused subscriptions
- Always carry a shopping list
- Find free entertainment
- Tackle credit card debt
- Cook at home
- Cut the cable
You’d be amazed at how much money you can save if you’re willing to spend a little time keeping your expenses in check.
Make More Money
Thanks to the internet, you can do a lot of things online and earn extra money.
- Do transcription or virtual assistant jobs online
- Sell your photos on stock photos websites
- Become a freelancer on Fiverr or UpWork
- Start a blog or podcast
- Drive for Uber or Lyft
- Fill out paid surveys
- Become a YouTuber
- Sell your stuff online
To avoid being a victim of online scams, never pay a website or an app membership or training fee. Also, before giving your personal information, always perform some background research.
Over to You
We have just started a new year.
Planning now is the best way to cushion yourself and your family against emergencies. Your future self will thank you for opening an emergency fund account now.
Remember, commit to using your fund only for true emergencies.
Hopefully, this guide helped you out a bit. If so, leave a comment and share it by clicking one of those great looking icons below.
This article was compiled by Hardbacon, which has designed a savings account listing fifty Canadian savings accounts Hardbacon also helps you save on credit card, chequing accounts, online brokers, robo-advisors, life insurance, mortgages and personal loans. If you want to go one step further and take control of your finances, you should download Hardbacon’s mobile app, which links to your bank and investing accounts, helps you plan for your financial goals, create a budget and invest better.