Emergency Fund basics

If you are battling with a huge debt load, chances are you probably don’t have any savings to your name. It can seem like a really daunting and potentially impossible task, but you need an emergency fund.

As I have written before, life happens; accidents happen. If you don’t have any savings to face these, you will create more debt. By the way, a line of credit is not an emergency fund; it is debt in the making!  Let’s also define what an “emergency” is. An emergency is a serious, unexpected situation requiring immediate action. Buying a plane ticket to Mexico to care for your mother on her death bed is an emergency. Buying a plane ticket to go to Mexico on vacation is not.

Before starting your fund, you need to have a budget in place, just like for debt repayment. The rule of thumb says you should allocate 10% of your net income toward savings. Depending on your debt level, income and expenses, it may not be possible for you to save this amount. Start with what you can, even if it is “only” $ 50.00 per month.

Your emergency fund should be liquid and quickly accessible. By definition, you won’t be earning high-interest on this money. Park it in a savings account or a TFSA.

There are lots of debates on “how much” one should have in an emergency fund. A lot of “experts” suggest 3 months of living expenses. Others say 6 months, or even a year. This represents a significant amount of money and will take some time to accomplish. It can actually be discouraging. I would suggest starting with a goal of $ 1 000.00. The point is to get started. Once you have reached this goal, aim for one month of living expenses, and so on.

To keep on track, set-up an automatic transfer between your accounts. Use any financial “boosters” you may receive such as a tax refund or a bonus from work. You may be tempted to put these towards your debt. Don’t, unless you have a collector harassing you or one of your debts carries a ridiculously high interest rate.

The leading cause of debt is not reckless spending, but lack of adequate savings to face situations like a job loss, an illness or a divorce. I know this first hand, as it was the result of my own personal debt; debt I am still paying off to this day….

A lot of “experts” also suggest you pay off your debt first, and then start saving. Based on my own experience, I (respectfully) disagree. You need to save, even if you have debt. That’s what I am doing. My debt is under control and in repayment, but my emergency fund is pretty low, about $ 1 600.00. I am also saving for retirement, but my main goal is to replenish my E.F. I am working on the first month of living expenses, i.e. $ 2 500.00.

3 thoughts on “Emergency Fund basics

  1. DIdier says:

    Thank you for this important article Stephanie !
    Paying ourself first is the key to make good progress in this journey to master our finance.
    And paying ourself first means starting with this emergency fund 🙂

    Like

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