On Emergency Funds: What Would You Give To Not Worry About Money?

I Don’t Think I Need Emergency Savings

If I asked you to recall some of your most stressful times in recent years, what are the chances that one or two, perhaps all recollections are related to money? If you are 18 and over, I would reckon very likely. One of mine definitely is – tail-end of summer 2015; a memory so sore I refuse to laugh about it. In as few details: Fast car, very tempting empty stretch of road (countryside), 2am on a summer weekend. As you can guess, it wasn’t an exhilarating ride. Fines, impound and legal fees quickly accumulated, souring the rest of my year. In hindsight, what that summer boiled down to was one bad decision revealing the false sense of security I had financially. Wage/Income – Check. Long-term savings/investments – Check. Emergency Fund – Oops!

You might ask “Why not dip into the long-term savings to tackle emergencies?” Well that was exactly what I did – a mistake as it turned out. Emergency savings, Rainy day fund, Safety net – whatever you choose to call it – are a necessity for a healthy life; not just financially, but also mentally. With this in mind, it is surprising that about 60% of individuals do not have savings to cover a $500 (or equivalent) emergency (You may say, “Not me”, but I’m not talking about the stash under you mattress or in that shoe-box). On the other hand, as a result of reaching adult age during the sub-prime mortgage crisis, more millennials are saving and or investing compared to previous generations. Good as that may be, we are skipping the essential step of setting up for emergencies. Car problems, Laptop/phone crashing, getting lost or stolen, pet issues (dog inhaling a pound of chocolate), unexpected fines – the word ‘emergencies’ may be the wrong word to use, as these are things you could expect to happen periodically. In these scenarios, most people actions fall into one or more of these categories:

  • No More Pizza Fridays”: Some may restructure their ‘budget’ to accommodate the unexpected spending. This is ok sometimes (an elastic budget is good), as long as you do not overstrain your finances.
  • Dip Into The Honey Pot: Others may dip into their long-term savings/investments. Wrong move. Is it worth the penalties and money loss involved? How long will it take to replace it?
  • This is what my Credit Card is for”: A few may turn to their 19%-23% APR credit cards. Trust me – better yet, trust the math – a safety net fund is better than racking up debt with interest.
  • Let Me Hold a Dollar”: A smaller section may borrow money from friends or family. It goes without saying that each individual’s families and friends are different from others. Nevertheless, make this a Golden Rule: Never lend to/borrow from friends or family. Slight exceptions of course, but it makes your life easier in the long run.

As risk management is key to financial planning, the simple solution is to plan for these scenarios and create a savings plan accordingly. Predict not react.

Help Me, How Do I Start?

There is no fixed formula for how much you should have in an emergency fund. Some school of thoughts say 6 months’ worth is sufficient, some say a year’s worth. Everyone’s situation is different and as such, each strategy should differ. To start however, I would suggest understanding your spending habits, and then implementing a 3-6-9 guideline.

  • 3 Months: If you are single without kids, renting, no car, partially dependent on parents for income or any combination of these factors, start off with a target of 3 months’ worth of expenses for a rainy-day fund.
  • 6 Months: Married, kids under 18, own a house or condo, own at least one car, or any of these combined, the base target should be 6 months’ worth of expenses (if married, base it off the income of the highest earner).
  • 9 months: Self-employed, freelancers, anyone with a volatile job or unpredictable paycheck, 9 months’ worth should be the benchmark.

If you noticed, I specified the worth in terms of expenses not paycheck. This is best especially for those just starting. By understanding your spending and calculating your basic expenses, you can have a general idea of how much to put into this fund. If you decide to determine the monthly worth in terms of paychecks, kudos to you. Key to this however, is to start out with small monthly (even better, bi-weekly) deposits till you reach your goal. If you are just starting out saving, set up this emergency fund before any long-term savings – or at the most, simultaneously. To help, make it an automatic withdrawal from your main account; think of it as a bill with the knowledge that every withdrawal from the fund has to be replaced.

Thanks, I’ve Hit My Target. What Now?

The 3-6-9 guideline is what it is – just a guideline. If you hit your benchmark, don’t stop. Sure, you can reduce the size of contributions but don’t stop. Emergencies are sudden (water is wet), and as such you need your emergency savings to be easily accessible when you need it (highly liquid) and safe. That does not mean store it in cash (that defeats the safety factor). The best suggestion is to keep it in an easily accessible tax-free account e.g. TFSA (ROTH IRA if you’re from the US). On reaching your set benchmark, further contributions can go into a RRSP (or 401K if you’re from the US), or a fixed-income ETF. This is so that you do not accumulate money that does not work for you.

There is a caveat with these accounts though: You can only withdraw contribution amounts from a ROTH IRA/RRSP without tax or early-withdrawal penalties within an age limit. So be sure to do your research before deciding to put your emergency funds in these accounts.

So, Let Me See If I Understand…

  • If your reply to “You should have an emergency fund” is “What’s an emergency fund?” you are carrying a significant financial risk.
  • Start NOW!
  • Understand your spending habits
  • Use the 3-6-9 guideline as a base benchmark for how much to contribute.
  • Start with small contributions, budget for these and develop discipline (Make the contributions automatic to help).
  • If you are uncomfortable with money sitting idly, re-direct further contributions past your benchmark to safe but better investments such as Roth IRAs, RRSPs or fixed-income ETFs
  • Any money taken out of a rainy-day fund should be put back as soon as possible.
  • Revel in the peace of mind that comes with financial security.

OMG, Thank You! Any Other Tips?

This is but one of many strategic choices towards healthy personal finance, but you can get ahead of the curve; be above average. The simplest way to do this is accumulate knowledge: READ, READ, READ or listen if you prefer. Go over previous and future articles on this website regularly, read a wide variety of books- personal finance included of course (YES, you do have time), and even though this seems as unspoken taboo, talk, talk, talk about money with friends and family – nothing to lose (pride is not worth it) and everything to gain. There are few better feelings than not having to worry about money.

Tell me – What steps are you taking to set up your emergency fund so you do not worry about money?

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