Emergency Funds: How to protect yourself from disaster
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The car breaks down and will cost $900 to repair. You get pneumonia and can’t work for a week, so your paycheque is half what it should be. Your cat needs to go on a particular (expensive) new food that costs $300 a bag. These are all super possible events that have the potential to gut your budget. How can you handle this situation without turning to debt or skipping your bills? The answer? An emergency fund. This post is going to dig into everything you need to know about emergency funds, from who needs one (hint: YOU do), when you need it (hint: now), and everything else you are wondering about the security of emergency funds!
What is an Emergency Fund?
Never, in my life, have I had more than a few thousand dollars in the bank. And that was on a good day. No wonder I was drowning in debt for so many years. Every single time an emergency came up, I’d turn to my credit cards because I had virtually no savings.
Sound familiar?
If you have debt, your first step in paying it off is saving one thousand dollars. This won’t save you from a big crisis, but it will provide a cushion between you and the plastic cards you have been relying on. This way, if any emergencies come up while you are focusing on your debt snowball, you can cover them without going backward and into more debt.
Related: How to stop letting simple setbacks lead to failure
But what about when the debt is paid off? Does that thousand dollars continue to provide the security you need?
Nope!
Depending on your job situation, you need to save between three and six months worth of expenses. And if you work for yourself or on commission, think about making it a year’s worth. Because what happens when the clients all disappear, and there is literally no income? The last thing you want to do is go back into debt!
In the beginning, when I couldn’t imagine having five grand in the bank without owing money to anyone, I was pretty set on a ten thousand dollar emergency fund. It was more money than I could fathom saving, as I’d never before had that much money.
To be clear, $10,000 is not three months of expenses, but I was tired of not enjoying my money right now, and I was making excuses.
Related: E is for excuses to let go of
But – the more the balance grew, the more I felt like we needed. Now that we have it up to three months, I feel pretty good, but I can see bumping it up further when we have some extra money. The point is to be protected and have some peace of mind.
What are ‘expenses’?
There are two camps on the answer to what constitutes expenses. And heads up, if you manage money as a couple, you may need to compromise and meet in the middle.
Some people feel expenses means covering the bare minimum – the bills you have to pay each month. Rent or mortgage, food, car, utilities, done. No extras, just bare-bones budget.
On the other hand, there are people who want three to six months of expenses to maintain their current cost of living. Including whatever you budget for restaurants, entertainment, clothes, fun money. This group does not want their quality of life to shift, so they opt to save more than the first group.
There is no right or wrong answer here – you need to find a number that works for your life!
Who needs an Emergency Fund?
Up until recently, this was not something that I felt like I needed. I was stressed about money, yes. But that was because I was deeply in debt and struggling to pay the bills. Once that debt was gone, my money stress was done, and I wasn’t really fussed about having a huge pile of money in the bank that I couldn’t use.
This is part of the reason it took us a year to save our full Emergency Fund!
But. Here’s the thing.
What we learned this year is that emergencies DO happen. We weren’t expecting to buy a new washer and dryer this summer. Much like we weren’t planning on buying a new (to us) car in November. But – life is full of surprises, and when the washing machine filled with smoke with six loads of camping laundry waiting to get cleaned, I was SO grateful to be able to head to Home Depot and replace them without losing sleep about how I would pay for it.
So to answer the question: you. YOU need an emergency fund to protect your financial freedom and your peace of mind.
The timeline
Your first step on your financial journey should be saving one thousand dollars. Right now. Before you make extra payments on your debt or sink a chunk of money into retirement investments.
Then, the timeline shifts depending on your situation.
If you don’t have any debt, don’t stop at a thousand. Keep on saving until you have a fully-funded emergency savings plan.
While you are rocking your debt snowball, keep your emergency fund at that sweet thousand dollar mark. Once you are debt-free, bring it up to the amount you feel comfortable with. Generally speaking, that is three to six months of expenses. See above for what expenses includes!
What if you already have a cozy nest egg tucked away, but you also have debt? It doesn’t make sense to have 15K locked away in a savings account so that you feel ‘protected’, while every month you slave away at the interest and minimum payments. Drop your savings down to a thousand and put the rest onto your debt payments.
It feels scary and awful – but use that discomfort to hustle your butt through the debt as fast as you can. Change doesn’t come in your comfort zone.
How do I save my emergency fund?
B.U.D.G.E.T.
The coconut oil of personal finance… the answer to every money struggle… the best tool to build wealth and financial freedom! Your budget!!
Using a zero-dollar budget lets you decide what every single dollar will be spent on or saved for. Once you’ve allotted funds for all of your mandatory expenses, put as much as you can towards your Emergency Fund until it’s done.
Haven’t started budgeting yet? Check this out, and we will help you get started!
Keep the snowball rolling
Since you have paid off all of your debt, you have freed up all of those minimum payments. Instead of dumping all that money onto your credit cards and student loans, now you can put them into your savings account. You still don’t get the immediate satisfaction of spending that money on fun things, but at least now you know it’s working FOR you instead of for someone else.
Quick Challenges
Try a no-spend challenge to help you save extra money fast. This is a fun little ‘game’ you can play to kick start or beef up your savings. Essentially, you pick a specific category of budget items and commit to not spending from that category for a set amount of time.
Some ideas for no spend challenges:
- clothes
- restaurants
- hobbies
- beauty products
- take-out coffee
- books
- subscription services
- food delivery
- date nights
This type of challenge only works if you choose a category that you a, spend money in, and b, can live without. Don’t plan a no-spend for groceries, because that isn’t a reasonable expense to cut. But you could choose to do a challenge for junk food or treats (the things we buy like groceries, but that really aren’t things we need).
Automate (or don’t)
Some people swear by having their savings automated. They set it so that a predetermined amount of money goes into their savings every month – they don’t even see it in their account, and then they can’t accidentally spend it on something else.
For my type A personality, I prefer to be in control, and I see these savings goals as a challenge that I want to complete as quickly as possible. So if I’m going to automate it, I’ll still top it up with any extra money I can get my hands on, so that it is done as quickly as possible.
Budget Cuts
Go back to that budget and see where you can trim things up.
Can you spend less on groceries?
Get a cheaper deal on your cell phone?
Or maybe you can cancel a subscription (think cable, Netflix, Spotify, etc.) or skip your weekly manicure?
There are almost always places on the budget you can tighten up for a while, to reach your goal.
Windfalls
This is absolutely one of my favourite things about intentional finance. There was a time, not that long ago, where we would get random, unexpected chunks of money, and they would drift out of our accounts on nothing. But now, because we have a plan for our cash, it’s like a surprise boost.
I’m talking about things like birthday money, tax returns, work bonuses. Any money that comes into your account that isn’t part of your regular income.
Yes, you can choose to do something frivolous with it. Or you can put it towards your Emergency Fund and know that you will be covered down the line. My peace of mind is worth way more than whatever I can mindlessly waste that money on.
Sell all the things
Need a boost to get your fund complete? Have a garage sale or sell stuff online. Anything you no longer use, need, or want – it might not be worth much to you, but even if you sell your old board games for $3 a pop, that all adds up.
Now that you’ve got it, where do you put it?
The golden rule of emergency funds is to put it somewhere that you do not have immediate access to it. This keeps you from falling victim to impulse shopping or accident spending!
You don’t want it locked in an investment where yes, you’ll make some good interest, but you’ll get penalized for pulling it when you need it. (Or worse, you won’t be able to pull it at all!)
I keep mine in a Tax-Free Savings Account because it is still earning some interest (more than a regular savings account), it takes a couple of days for the money to transfer to my chequing account, but I don’t get hit with any penalties for pulling it out when I need it.
A regular savings account is also a FINE option, but my advice is to make sure that that account is not linked to your debit card, so you can’t accidentally spend it. I keep my sinking funds in a savings account where I have to transfer the money into my chequing account online. I cannot spend directly from that account, or I pay a $5 transaction fee — quicker access than my TFSA, but not convenient at all.
When do I use it?
Truthfully – hopefully never. I hope that your ten, fifteen, twenty thousand dollars sits in that account, slowly building interest and that you never have an emergency and need to pull it.
BUT – that’s not likely. The key is deciding when to use it. What is an emergency, and what is an expense that you can reasonably cover in your budget?
If your grandma is sick and you suddenly need to book a four hundred dollar flight, you might be able to cover that without using your emergency fund by trimming some budget expenses.
But if a giant hail storm rips a hole in your roof, you’ll probably need to dip into your savings to cover the repairs or, at the very least, your insurance deductible.
Don’t use this money on a whim to pay for something you really want but can’t afford. I could go on a fabulous vacation with my emergency fund. Or start into the home reno projects I’m dying to do. But, for real, my peace of mind is worth so much more than that instant gratification!
Before you dip into your Emergency Fund, ask yourself – is it necessary to spend it? If your car dies, and you need it to commute to work, then paying for repairs is necessary. But if your barbeque dies, you can probably survive without it until you save for a replacement. See what I’m getting at? Be mindful of what you deem an ’emergency’.
And, finally, my biggest lesson as I’ve locked my emergency fund in place has been that I can cash flow a lot more than I think I can. When I need to, I can tweak my budget, make some cutbacks, or bump my income to cover a lot of expenses to protect the money that is there to protect me! Funny, because a few years ago I would have had zero dollars in the savings, and because I didn’t have a budget I would have for sure turned to my credit cards to pay for any and all unexpected expenses that came my way!
Wrap Up
If you take away anything from today’s post, let it be this: you need an emergency fund now. Don’t tell yourself you don’t need it because nothing bad has ever happened. And please don’t wait to start it, because you won’t have it when you need it.
Financial freedom means delayed gratification and making a plan for your money – intentionally planning for the emergencies that life throws your way.
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