Do I really need an emergency fund?

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Did you know that an emergency fund is an important part of a financial plan? This fund will not only keep you afloat in times of need, it will also prevent you from incurring debt that can derail your finances for years to come.

What is an emergency fund?

An emergency fund is money you set aside to use for unforeseen events or for needed but unplanned spending. Examples of these would be a sudden illness that needs hospitalization or fixing a leak in the roof of your house. Experts advise saving an amount equivalent to three to six months of your salary for emergencies. A more conservative estimate would be three to six months of your living expenses (see Community Resources below for Emergency Fund calculators). The amount depends per person or family but if you are just starting out, a safe target to begin with is covering three months of your household expenses.

Building an emergency fund is essential because it keeps you from maxing out your credit card (which can mean a bigger expense due to high interest) or dipping into your retirement fund, or your child’s college fund whenever unexpected expenditures occur. Having this fund gives you peace of mind and keeps your finances stable whatever comes your way.

Watch this video from Fidelity Investments to learn about the “Three things you need to know about an Emergency Fund”:

What counts as an emergency?

When we talk about emergencies, we mean situations such as the following:

• Losing a job
• Medical emergencies
• Essential house repairs
• Car repairs (especially if it is your only means of transportation)
• Bereavement-related expenses (travel, burial or hospital expense for the death of a relative)

How to start building an emergency fund

You can start by regularly saving small amounts every month. According to Rob Carrick, personal finance columnist of The Globe and Mail, a fast way to start is by “using a lump sum amount like a tax refund, bonus or gift.” Other ways to start would be:

• Saving money from a bonus or earnings from a sale of an asset (e.g. a second car you don’t use, equipment, furniture from a garage sale, etc.).
• Rerouting money saved from cutting household expenditures such as cable TV consumption or payment for a landline if you already have a cellular phone.
• Saving half of your vacation budget by choosing a less expensive holiday.

Whether you start small or by using a lump sum, the important thing is to start building the emergency fund before emergencies occur (which essentially means now).

Where do I keep it?

It would be ideal to keep a separate account for your emergency fund at a bank or credit union. The fund must not be too easy to take out from, and yet “liquid,” meaning it can be easily withdrawn when you need it. It is also essential that the money is protected from sudden downturns in the financial market, so avoid risky investments. Experts suggest keeping your fund in a high-interest savings account or a Tax-Free Savings Account (TFSA) which may not yield high interests, but will keep your fund secure and easily accessible.

Keep saving! Every bit counts

The Golden Rule of saving is to “pay yourself first.” Setting aside even a small amount every pay day is a good habit to have. It will total up to big savings before you know it. You can set automatic, regular transfers from your payroll account to your emergency fund account (or savings account) every pay day so that you don’t even notice it. Also remember to put back whatever amount you take from your emergency fund to keep it intact and growing so that you are always ready for all of life’s surprises.