The importance of the emergency fund

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I have heard a lot of names for the Emergency fund: Back-up fund, F-U fund, Opportunity fund, Rainy-Day fund…whatever you want to call it, it is just semantics.

The purpose of said funds is the same: to have some cash in hand when s**t happens. And yes, s**t will occasionally happen, no matter how much we pretend it won’t.

I have written about having an emergency fund before. My views on this matter haven’t changed. With this post, I want to go from theory – i.e. having an emergency fund- to practice -i.e. dealing with an emergency-.

ENTER MY DRIVING WOES

It all started in 2014. That year, I was involved in a minor collision for which I was found 100% responsible. I had to pay a deductible when getting my car fixed. At the time it was $300, no big deal for my wallet.

In British Columbia, it is possible for the at-fault driver to reimburse the insurer for the repair costs to both vehicles, provided there is no injury claim. Doing so also “protects” the insurance premiums of the at-fault driver from increasing.

In my case, the other driver claimed injuries so I could not do this and was assessed a premium surchage over a 3-year period. In any case, I wouldn’t have been able to repay , as I simply didn’t have the extra money back then.

DRIVING WOES-TAKE 2

Fast forward to 2017, I hadn’t had any at-fault accident since then, when I was involved in another minor fender-bender for which I was also found 100% responsible!

My deductible was $ 500 this time, again no big deal for my wallet. However, because of the 2014 accident, I was looking at a hefty premium surchage. The only way for me to avoid this was to pay for the repair costs on both vehicles, AND that the other driver did not claim injuries.

THE CASE FOR THE EMERGENCY FUND

I was extremely lucky that the other driver did not sustain injuries. I was also lucky the collision was minor. The total extra costs came at just over $ 2 800.00, which I was able to repay and this is what I actually did.

All in all, the total amount I forked up-front for my driving mishaps was $ 3 600.00. The upcoming surchage I was looking at was 3 times that amount!

I might be Captain Obvious here, but I am glad  my emergency fund was here to get me out of the hole I had dug for myself! If I hadn’t had one, it would have cost me an extra  $10 000, on top of the regular premiums. That would have been a big chunk of dough!

CONCLUSION

I have yet to hear anyone -including myself- wishing they didn’t have an emergency fund when s**t hit the fan.

Much has been written and said about the good, old emergency fund. There is no question pretty much anyone needs one, including those with a hefty saving rate and those financially independent. A portion of assets should be designated as emergency fund.

Whether one needs $ 10 000, 3 or 6 months of expenses and whether said monies should be held in a plain savings account are discussions for another post.

In the meantime, and in light of these car events, I may need to devote some money for driving lessons….and that is also a discussion for another post!

Financial rules I like to bend or break

There are many financial rules we hear over and over again, and that we blindly follow. But before following any rule, we need to see if it is actually adapted to our own situation. The key word in personal finances is personal.

  1. Live within your means. Sure, this rule makes sense at first, when you try to get a grip on your money. But once you have done that, you actually need to live below your means in order to save. If you spend all your paycheque, how will you achieve this?

 

  1. Cut expenses drastically. You can only go so far in terms of cuts. I am a proponent of earning more instead.

 

  1. Have 3 to 6 months of living expenses or a minimum of 10K in an emergency fund. Who decreed these numbers were an absolute must? I personally don’t like the concept of an “emergency fund”. I have this theory that, if you focus and obsess on “emergencies”, it is exactly what you are going to get. I prefer using the term “back-up fund” instead. It is just semantics though. I am not saying you shouldn’t save, but the amount you decide to put aside is entirely up to you. If you have a good cushion, it shouldn’t be sitting in a plain savings account earning 0.5%. Consider investing a portion of it in a low risk product.

 

  1. Buying (a house or a car) is the only way to go. Do the math before abiding by this rule. Review your personal situation as well.

 

  1. Always max out your RRSP contributions. In a perfect Canada, we would all contribute the full amount to our RRSPs each year. But it is pointless to set money aside for retirement if you can’t pay your bills, or if you don’t have a back-up fund. An RRSP might also not be the right investment tool for you.

 

What about you? What financial rules have you broken or bent?

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.