Emergency Fund: Why Is It Essential?

What would you do tomorrow if you had an unexpected expense of $1000, $2000 or even $5000? What if you lost your job overnight?

Would you have the money set aside to cover a large expense or to cover your living expenses until you find a new job?

That’s where the emergency fund comes in! Acting like safety net, it helps you deal with urgent and unexpected situations and reduces your financial stress, all without compromising your personal finances.

In this blog post, we tell you all about this financial cushion that you should start setting aside today (if you haven’t already) to be financially prepared for all of life’s mishaps.

When should an emergency fund be used?

The money saved in your emergency fund should be used for immediate, essential expenses that are not part of your regular budget. These expenses may include contingencies such as:

• A major mechanical problem with your car;
• An exceptional medical or dental expense not covered by your insurance;
• An appliance breakdown;
• An emergency visit to the veterinarian;
• A leaky roof;
• A health problem that prevents you from working;
• Etc.

This money can also be used to make up for the loss of a job or to cover your expenses while waiting to receive employment insurance. For people whose income is unpredictable or fluctuates, such as the self-employed, it can prove useful during less busy times.

Why have an emergency fund instead of…

…using credit?

You may be wondering why you should set aside money for unexpected expenses when you have a credit card. The short answer is that credit… is expensive!

Imagine having to pay an unexpected expense of several thousand dollars with your credit card – while still paying for your regular expenses, of course. When you don’t have the money set aside, it could take much longer to pay off the entire balance on your card! Interest charges of up to 19% will then accumulate month after month and will be added to any new purchases you make.

As a result, you’ll end up carrying this debt for a long time and paying more than you should have for this unexpected expense. Ouch!

…using your RRSP?

With your retirement seemingly far away (or not so far away), it may also be tempting to turn to your RRSPs to pay for an unexpected expense. It’s money you’ve set aside, after all, so what’s the difference with an emergency fund?

Well, here’s the difference: by using your RRSPs, you’ll have to pay tax on the money you withdraw. In addition, you will lose the advantage of compounding, which is the continuous growth of your money year after year.

To learn more about RRSPs, we recommend you read this blog post:

10 RRSP Tax Advantages You May Not Know About

Where should you deposit the money for your emergency fund?

First of all, it is recommended that you save the money for your emergency fund in a separate bank account. This way, it’ll be easier to resist the temptation to use the money for other (more fun) expenses! This account should also allow you to access your cash quickly if it becomes necessary.

A simple savings account is an appropriate option.

You could even use a TFSA with low-risk investments to avoid fluctuations in your savings. This way, you can take advantage of potential tax-free investment income!

To find out if this option is right for you, we invite you to discuss it with your financial advisor. Please don’t hesitate to contact us for more information.

How much money should you put aside for your emergency fund?

That’s the big question! And the answer is that the recommended amount… varies according to multiple factors such as your age, your income, the stability of your income, your expenses, your financial situation and your debt level.

So how do you determine the amount YOU need for your emergency fund and set it aside? Let us explain:

Setting up an emergency fund

1. Calculate

Generally speaking, it is recommended that you set aside an amount that can cover your basic expenses for a period of three to six months. This includes your rent or mortgage, groceries, telecommunications and any other financial commitments (student loan or car loan payments, for example).

Note that if you lose your primary source of income, leisure expenses (entertainment, dining out, vacations) and potentially even retirement savings will normally be much lower than normal, if not zero. For this reason, it is not necessary to include them in this calculation.

You should also consider the following:

• If you lose your job, will you be eligible for Employment Insurance or disability insurance? If so, your financial cushion may help you support yourself until you receive your benefits.
• Are you a homeowner? If so, the chances of encountering unexpected (often costly) expenses are higher, and as a result, the amount available in your emergency fund should reflect that.
• Does your income tend to vary or be unpredictable? If so, it is a good idea to build up more savings (the equivalent of six months of expenses or more).

To calculate the appropriate amount according to your unique situation and ensure you don’t miss anything, you can use this online Emergency Fund Calculator on Hard Bacon’s website: https://hardbacon.ca/en/calculator/emergency-fund-calculator/

2. Budget

Once you know how much you need to set aside, you should spread the amount over several months to help you gradually reach that goal. By including it in your budget as a standard expense, you’ll quickly be able to see how much is realistic for you to set aside each month to build your emergency fund.

3. Automate your savings

Next, simply schedule regular pre-authorized automatic payments from your checking account to your savings account or TFSA dedicated to your emergency fund. You can stop contributing once you’ve reached the planned amount.

4. Review your goal

Many changes in your situation may require you to save more money for your emergency fund: the arrival of a child, the purchase of a house, an increase in the cost of gas or electricity, etc.

Remember to review the amount you need in your emergency fund periodically so that it meets your current needs at all times!

In conclusion

Building an emergency fund is certainly not the most fun form of saving. But it is one of the most effective ways to ensure your financial confidence and well-being! Because you’ll know that no matter what problems arise – a burst pipe, a layoff, your car breaking down – you’ll be able to deal with them without going into debt.

It’s never too late to start saving for this goal, but the sooner you start, the sooner you’ll be ready for the unexpected!

Need some tips on how to get there? We’re here to help! Contact us for more information.