The phrase “saving for a rainy day” may be overused, but it contains an important truth: you can’t control the weather, but you can be prepared for it. These days, it seems like there’s a lot of stormy weather, with everything going on in the economy. 60 percent of Canadians say they’re concerned about how they would pay for an unexpected expense, according to our Financial Wellness and Literacy poll.
No matter how much money you earn, it’s ideal to have cash earmarked for the kinds of situations everyone hopes won’t happen — a flooded basement, a busted car transmission, being too sick to work. This can save you from having to scramble when your best-laid plans go wrong. This is what we call an emergency fund, and here’s how to get started with creating yours.
To be safe, an emergency fund should cover 3 to 6 months’ worth of expenses. If you have a partner, no dependents, and you both work, you could aim for 3 months. But strive for 6 months if you rely on your income alone. This will also keep you better prepared if you have dependents, tuition, mortgage payments or other large fixed monthly costs.
Add up your monthly expenses. The obvious ones are groceries, rent or mortgage payments, utilities, telephone bills and car payments. Don’t forget the not-so-obvious ones: streaming subscriptions, food deliveries and other costs that may not come to mind right away. Multiply the total amount by 3 to 6 months to get your target emergency fund amount.
For more help with gauging your average monthly expenses, you can use our budget calculator.
Consider keeping your emergency fund in a savings account. Or, use a low-risk, open investment like a money market fund. You’re looking for stability and accessibility, not high returns. You could hold a guaranteed investment certificate (GIC) as part of your emergency fund, but make sure that it’s a cashable or redeemable GIC. This way, your money isn’t locked in and is available if you suddenly need it.
To build your emergency fund, make regular payments into the account you choose. No amount is too small. Avoid substituting emergency fund payments for retirement savings investments — it’s in your best interest to do both if possible. And remember, you’re never too old to start saving.
Don't touch your nest egg
In a pinch, cashing in your RRSP may seem logical — it is your money — but you'll lose the benefit of compounding. This is the ability to keep that money growing year after year. Also, there are tax consequences to withdrawing money before you retire. This could do you more harm than good when you consider your overall financial picture and future goals.
So, what other options do you have if you need to come up with some cash, and your emergency fund is still a work in progress? One product that may help is a line of credit. You only pay when you owe a balance, so you can open one anytime and draw from it when needed.
Before taking this route, it’s important to look at the interest rate and make sure the monthly payments are manageable.
Setting up an emergency fund can be one of the keys to financial confidence and wellbeing. Should the day come when a pipe bursts in your home, or you get sick or laid off, the money you’ve been setting aside could be your saving grace.
Knowing you’ve got a plan could also help you relax a little more today. After all, when you’re carrying an umbrella, you don’t worry so much about the rain.