In a previous article (Build an Emergency Fund and Avoid Borrowing More Money) we discussed how an emergency fund was the first important step to stop debt accumulation in its tracks.
If you followed that advice or are lucky enough to have a small amount tucked away that can function as your emergency fund, it’s time to start adding to it to prepare for a real emergency.
The ultimate goal of an emergency fund is to have a chunk of money that acts as a stabilizer for your entire life.
Roof collapses? You can cover it and not have your other goals and priorities take a hit.
Lose your job? You won’t have to panic and get a job in retail to pay the gas bill because you have an emergency fund that buys you time to find a job you actually want.
The truth is, with a well-funded emergency fund, you’ll be amazed that you’ll start having less emergencies. What would have previously been a complete crisis becomes nothing more than a minor inconvenience.
How Big Should Your Emergency Fund Be?
We get asked this question all the time, and the fact is it’s different for everyone. The ideal target is to have 3-6 months of expenses saved up.
The easiest way to calculate this is to just take all your monthly expenses and multiply it by however many months you are comfortable with. If the cost of your home, cars, insurance, utilities, internet, cell phones, etc. is $3,000 a month, then you’re going to need between $9,000 and $18,000.
Does that seem like a lot? It is. At some point, having that much money sitting around gets impractical.
That’s why the second part of the calculation is figuring out what you can live without if an emergency hits. Could you cancel a gym membership or your cable? Maybe you could sell one of your cars or take other drastic actions. This will be up to you but just remember the goal of the emergency fund – to keep you going while you get back on your feet.
Where Should I Keep The Money?
This is also a great question. Most people see $10,000 or more in their account and want it to be making money for them. You have to remember that an emergency fund is meant to be used when there’s an emergency. If it’s locked in a GIC and you’re going to get penalized for withdrawing some of it, that is probably not the best idea. If it’s in anything riskier, then you run the double-risk of the value going down and not having enough when a disaster strikes.
So take a deep breath and accept that this money is not part of your retirement fund and you don’t need to see double-digit returns on it.
A simple chequing or savings account is fine. Online banks like ING or PC Financial may offer higher interest saving accounts, and that’s of course fine to take advantage of.
Some people also decide to keep their emergency funds inside their TFSA. This is fine until you have to withdraw, when putting money back in may get complicated depending on how much room you have available.
Keep in mind that, at the moment, even a 2% return is pretty good for a savings account or GIC. On $10,000 that’s $200 per year.
For this part of your money, play it safe and keep it simple. Easy access is the name of the game.
One Step At A Time
If the idea of having $10,000 or more in the bank seems like a pipe-dream, don’t worry. It’s good to look forward and see what an ideal situation looks like.
Don’t get frustrated or think your situation is hopeless just because it’s not going to happen for awhile.
The important thing is you know where you’re going and you have a plan. Don’t have the first $1,000 in your emergency fund? Can you find $500? What about $100?
Even $100 in an account that you don’t spend changes the way you think about your money. It’s empowering to see an account that increases, even if it’s only $25 a month.
Everyone starts somewhere – so get started – you’ll be amazed how quickly things turn around.