Canadians are carrying record levels of debt and the financial tactic that could improve things is the first thing to go when getting rid of that debt becomes Job #1. I applaud anyone who wants to get rid of their consumer debt as fast as they can. But having a single focus is never a good way to create balance.
Emergency funds (EFs) are an important part of being financially stable. Money in the bank gives you options so that you can stay on track even when you’re facing life’s challenges. With no cash at the ready, you’ll be forced to use your credit to deal with the water in your basement, unexpected medical bills, or replacing the appliance that just gave up the ghost. Cash means you can keep your financial plan in place AND deal with the crisis that has come a’knocking.
If you’re thinking, “I can’t see the point of letting money sit earning next to nothing,” you are focused on the wrong thing. Return isn’t the priority with an emergency fund. Access is. Stick that money into an investment and it may not be there just when you need it most. Stick it in a high-interest savings account and while you may be irked by the interest rate, the emergency fund will be there when you hit the wall. The point is to have some wiggle room when the unexpected happens.
So how much is enough? If you want a realistic emergency fund – one that actually gets you though the rough – figure our your monthly essential expenses and multiply by six. That’s how much you need.
Sure unemployment insurance may help fill the gap if you lose your job, but it doesn’t go far. And unemployment isn’t the worst emergency you may face. Get sick and watch your money evaporate. Even if you have good health and disability insurance plans, your cash flow will still take a kicking until your benefits click on.
As for the banks telling you to get a line of credit and use it as an emergency fund, that’s rotten advice. A line of credit is not an emergency fund… it is debt waiting to happen. If you end up racking up tens of thousands in debt on an LOC, how is that diverting disaster?
Let’s say your kid breaks their arm playing in the yard. With an EF you have the money you need to take a day off work, get them to the hospital, and cope in whatever other ways you must without going into debt. If your mate is downsized, you can still pay the mortgage and keep food on the table until they find a new job. Bang up your car, watch your shingles blow off in a windstorm, or find yourself in the throes of a divorce and you have the means to keep your financial boat afloat while you find ways to cope with all the other stress in your life.
The best way to create an emergency fund is to set up an automatic deduction from your regular account to a high-interest savings account. If you don’t have much to save, that doesn’t matter. Just start. Convert your intent into action. Commit $25 per pay to your emergency fund. Now you’re on your way and it only becomes a matter of how to boost the amount you’re setting aside to grow your stash of cash.
Do you have expenses you can trim to boost those savings. Do you buy coffee every day? Figure out how much you’re spending, cut it in half, and send the difference to your EF. Smoke? If you smoked half as much, how much would you be able to sock away? Pick up the latest magazine at the checkout counter? Subscribe to premium cable? Go out for a drink with your friends after work? Buy your lunch? How quickly could you build your emergency fund by focusing on being safe as opposed to being satiated?
If you’re determined to keep all your small indulgences, try the Tit-for-Tat approach to building up your stash of cash. Each time you satisfy a WANT, contribute an equal amount to your EF. Not only will it make you really think about whether you’re going to spend the money – in essence whatever you buy is going to cost your cash flow twice as much from cash flow – you’ll be giving yourself options for the future while you enjoy yourself today.