An emergency fund is fairly self explanatory when it comes to your finances, as it is simply funds set aside for an emergency. This comes up in conversations with all clients as an emergency fund is important when working with risk planning, investment planning, cash flow/debt planning, and really, just your overall financial plan.
So what really constitutes a financial emergency?
Well, it is typically any unexpected event thrown at you that your regular cash flow is unable to manage. Usually, these sudden developments can be very stressful and costly for people. Some of the more common emergencies would include:
-Loss of employment - losing ones job is not only stressful, but obviously can be very financially devastating, especially if unemployed for an extended period of time.
-Unanticipated home repairs - this would include major issues that need immediate attention such as replacing a furnace, fixing a roof, or anything unexpected and more costly than regular maintenance.
-Vehicle breakdown - this one always hurts, especially if there is no warranty coverage left on the vehicle.
-Medical emergency - sometimes medical emergencies can be covered through your benefits, disability insurance or critical illness insurance, but still always a good idea to have extra funds set aside, especially if you do not have sufficient living benefits in place.
-Investment opportunity - for active investors, always having some cash available will be important whether buying a dip in the market or having funds available for new investment opportunities.
-Unplanned travel - this one is maybe not as essential as the others, but it is always nice to have money available just incase. It will be better option to use an emergency fund for this instead of putting it on a credit card or line of credit.
Not only will an emergency fund increase your net worth, having one will typically keep you from making poor financial decisions and/or keep you from spending on a whim. Having to use a credit card, retirement savings, or borrow from family is definitely something everyone should avoid if at all possible when an emergency strikes. I recommend having a separate savings account used only for emergencies, and sometimes would even recommend having it with a different banking institution to keep it out of sight and out of mind. Less temptation to spend it if it is not directly connected to your debit or credit card. There are plenty of savings account options available to Canadians that offer high interest and low to no fees. A non-registered investment account or TFSA (if not being utilized for retirement) in a money market fund would be a great option as well, as they are safe and highly liquid when you need to access.
So how much should I have in my emergency fund?
That's the million dollar question which isn't so black and white, but typically I recommend having anywhere from 3 to 6 months worth of expenses. Sometimes 6 months of expenses may not be enough, especially if there is an extended layoff at a job, major medical emergency, or a prolonged recession, but 3 to 6 months is a pretty good rule of thumb to follow.
Don't have an emergency fund?
Don't panic and feel you need to find thousands of dollars somewhere and put it in an emergency fund immediately. Most Canadians won't be able to do that, but be aware of the potential risks in your life and financial plan and try and slowly accumulate money in one week to week or month to month. Having small amounts of $25, $50, $100 or higher being redirected from your bank account every pay cheque is a great way to fund these accounts. This will not only fund this account
over time, but it will unintentionally create good financial habits for yourself as well making it easier to save for other expenses such as a house, a new car, retirement, or managing debt. Tax refunds or inheritances are other good options to help fund these accounts. Completely focusing on only funding this account would be a mistake though, as it is important that it is worked into your overall financial plan and find the balance between your cash flow, debt management, saving for retirement, and other financial goals.
-Marty Metz, CFP, CLU
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