I often find myself thinking of the poem by Robert Burns titled, ‘To a Mouse’ and specifically this line, “The best laid schemes o’ Mice an’ Men / Gang aft agley” (Translation: The best laid plans of mice and men often go awry.)
It is a ubiquitous sentiment. Unless you’re Elon Musk (Or even then, I suppose) chances are at some point in life, you will have an emergency that will require you to shell out an unexpected amount of money. It could be a vet bill, or a car dent, or some dental work, or unexpected job loss, or health issues for yourself or a dependent.
That’s where having an emergency fund comes in.
What is an Emergency Fund?
An ‘Emergency Fund’ is exactly what it says – a chunk of money that is kept aside for a rainy day. It is money that you save for any unexpected expenses, so that when the time comes, you have it ready.
Emergency funds can be a good buffer in times of stress. If you have one, you won’t need to worry about covering unforeseen expenses, and you won’t have to take a loan, or get into debt. These funds should be kept aside for true emergencies, not for recurring expenses. For instance, in most of Canada, chances are you need winter tires – these should not come out of an emergency fund. But if you dent your car after swerving on ice? An emergency fund could help.
It may be common to think that funding one’s financial goals first, and then building and maintaining an emergency fund, is the right. I’d argue that is backwards. In my opinion, you should first fund your emergency fund, and only then start to invest and save for other financial goals. Here’s how I look – if an emergency comes up and you need to spend money that you don’t have on hand, you might have to sell investments at a loss, which may not be the best outcome for your goals.
How Much Money Should I Have in My Emergency Fund?
A lot of people hate this answer, but truly, it depends. If you have a steady job, no debts, and live a very frugal lifestyle, chances are you will need less than someone who has a gig economy job, or has many debts with varying interest rates and payment timelines.
Most experts agree that you need to save at least 3-6 months of essential expenses. You might need a little bit more, or a little bit less, it would depend on what makes you comfortable.
Tips for Building an Emergency Fund
While it may seem daunting to build up an emergency fund from scratch, if you break it down into steps, it gets easier. Here is a plan that you can start with and then customize for your own use.
Step 1: Have a Specific Number Amount
It is very important that you have a specific goal amount in mind when you begin, it’s alright if you need to change the number later. For this, the standard 3-6 months of expenses rule is a good starting point. Add up the important expenses in your life. These could include rent or mortgage, groceries, car loans, insurance, utilities, debt payments, childcare, or any other expense that you need to pay every month. Once you have that number, multiply it by 3 to 6 times. That’s how much you need. Even if it feels like the starting number is huge, you at least know how big the mountain is – all that’s left is to climb it.
Step 2: Start Saving. Automate if You Can.
Now that you have your number in front of you, start building it up. One easy tip is to automate a fixed amount that goes out of every paycheck. Even if it does not seem like a lot, over time, it adds up. If you put $50 per biweekly paycheck into your emergency fund, by the end of one year, you’ve saved $1,200. Maybe more. Which brings us to the next step.
Step 3: Use a High-Interest Savings Account (HISA)
Locking your emergency fund away in a GIC isn’t ideal, since emergencies are unpredictable and you never know when you might need the money. If you end up with a GIC that has a charge to break it and take the money out early, that will eat into your emergency fund. So, you want to consider a HISA, or a money market exchange traded fund like the Harvest Canadian T-Bill ETF (TSX: TBIL) that is designed as a low-risk cash vehicle that pays competitive interest income that comes from investing in Treasury Bills issued by the Government of Canada. That way, it is in a liquid vehicle where you can access it easily and get some small income on it.
Very Important Side Note: It is a very bad idea to use your emergency fund to invest in stocks, or cryptocurrencies, or anything that you think will give you faster growth. Even if you buy a stock that you think only has endless upside, this is still a risky proposition. Pick an investment vehicle that is low risk, even if it gives you lower returns. Your emergency funds has one job and one job only, and that is to be there for you when you need it most. You don’t want to worry about timing the market, or selling at a loss when you need the money most.
Step 4: Excess Cash Goes Into Your Emergency Fund
Any time you get any excess money, put them into your emergency fund. This could include tax refunds, or bonuses you get from employers, or even cash gifts from grandma. As soon as you get it, put it into the emergency fund, before you end up spending it all.
General Tips to Maintain an Emergency Fund
Once you have built your emergency fund, it’s on to the next thing, which is maintaining it. Here are three important tips on how to do just that:
Tip 1: Know What an ‘Emergency’ Is.
I often think this is the most complicated part of maintaining an emergency fund. Most people are not clear about what constitutes an emergency. While a sale on a coat or outfit that you’ve been waiting to buy may feel like an emergency, is it? Probably not. But if you rip your winter jacket in Alberta in January? Yes, that could be an emergency. The best way to have it clear is to define what an emergency is to you. You could save it as an email or write it down somewhere. That way you know exactly what an emergency is, and you’ll have clear permission to use your emergency fund only when it really matters.
Tip 2: Start Replenishing. Immediately.
The point of having an emergency fund is that you have the money ready for when you might need it, which means that chances are you’ll need it at some point. Use it calmly, that’s what it’s there for. But once you do, you need to replace it. It would be perfect if we had just one emergency all our lives, but chances are that’s not likely. So you need an emergency fund, even after you’ve used it. Start building it back up right away.
Tip 3: Review It When You Need To.
I usually ask my friends to review their portfolios and emergency funds annually. But that is just a suggestion. An emergency fund needs a little more attention. If you get a raise at work, and lifestyle creep comes in, you’ll need to up your emergency fund as well. If you have a child, you’ll need a different number. So make sure your emergency fund is always up-to-date, and that your target number accurately reflects where you are.
Remember, an emergency fund buys you peace of mind, oftentimes when you need it most. Think of it as an insurance policy that makes sure you’re covered, and not desperate. Good luck!
Disclaimer
The views and/or opinions expressed above are of a general nature and are for informational purposes only. The contents should not be considered as advice and/or a recommendation to purchase or sell the mentioned securities or used to engage personal investment strategies. Any security mentioned herein is for illustration purposes and should not be taken as an invitation to purchase or sell such security. Investors should consult their investment advisor before making any investment decision. Tax, investment and all other decisions should be made with guidance from a qualified professional.
Commissions, management fees and expenses all may be associated with investing in Harvest Exchange Traded Funds (managed by Harvest Portfolios Group Inc. (the “Funds”). The funds are not guaranteed, their values change frequently and past performance may not be repeated. Please read the relevant prospectus before investing.
