How To Build An Emergency Fund

So you’ve paid off all your debt and want to start to build your savings and investments? Before you start working on building up your RRSP, your first savings priority should be an emergency fund.

I’ve mentioned previously that I don’t believe an emergency fund makes much sense if you still have debt. By paying down debt on a credit card or credit line, you then free up that balance, which could be re-borrowed in the event of an emergency.

At the same time, paying down your debt, especially if it is high interest debt, allows you to stop wasting money on interest payments. The longer you are in debt, the less money you have to build up your own wealth. One of the best things you can do for yourself is to get rid of high interest debt as soon as possible. Once that is done, it’s time to build an emergency fund.

Why an Emergency Fund Matters

If your debts are paid off, an emergency fund acts as a form of insurance. The money is there if you truly need it, without having to go into debt or withdraw from your RRSP.

Most often, emergency funds are described as a safety net in case of job loss. Another good use for an emergency fund would be to use it for your home or auto insurance deductible. Having the money saved in advance gives you the ability to raise your deductible to reduce your insurance premiums. This saves you money on premiums each month — money that you can put into your emergency fund to earn interest.

Building Your Emergency Fund

It’s likely that you’ll need to save up to reach your emergency fund goals, so how much is the minimum you should have in your emergency fund? Rules of thumb suggest that you save up anywhere between 3 and 12 months’ worth of expenses. I think a true bare minimum would be either enough money to cover one month’s expenses or your insurance deductible, whichever is highest. Maybe this is $1,000 for some, while it might be much more for others.

You might have to start small to reach your initial goal, and that’s ok. The important thing is to get in the habit of setting money aside. How To Build An Emergency FundPut aside as much as you can until you hit your bare minimum. Use a high yield account so that you can make the most out of your interest yields.

From that point, keep adding savings from each pay cheque until you reach an amount you feel comfortable with. Once you have the total amount saved in your emergency fund, you can practically forget about it until the need arises.

You want to be able to get your money out quickly in the event of an emergency, so make sure that the money is in an accessible account. A high interest savings account, possibly within a TFSA, would be a good choice. However, it’s important not to have this money too accessible. A debit card linked to your emergency fund is usually not the best idea.

Keep in mind that this account is for true emergencies, not for a car, vacation or Boxing Day deal. Of course, now that you have an emergency fund, you can now start saving in separate accounts for these items as well!

Written by Tom Drake

Tom Drake is the owner and head writer of Canadian Finance Blog. While you’re here, consider signing up for the RSS feed or email subscription. Both deliver the latest articles directly to you everyday! Have a Twitter account? Then follow me for all the latest posts or to send me any comments or questions!

9 Responses to How To Build An Emergency Fund

  1. threadbndr says:

    I divide my efund into several ‘buckets’ – there’s a job loss bucket, and a deductibles bucket and a car/house emergency bucket. By keeping the accounts seperate (I love ING for this – they let you have as many linked accounts as you need), I don’t feel like I’m starting over if I need to tap one of the funds.

    For example, I just bought a new to me car and a big chunk of the car budget was added to the down payment (since the new car is under warranty I don’t need much in that bucket right now). But my job loss, insurance deductible and house funds were not impacted at all and grew at their normal rate this month.

  2. Tom Drake says:

    threadbndr,

    That’s a good idea, and it stops the temptation to use funds for something other than their purpose!

  3. Giselda says:

    In reply to Threadbndr, that is a great bit of information you gave. I love ING as well, it is a great way to save, but I am wondering, how do you get all the accounts, like what you mentioned? For me, this would be a great idea.

  4. Allison says:

    Loved this post! It’s so important to establish an emergency fund. You can never fully anticipate what you’re going to be spending your money on over the next month, six months, year….It’s also important to protect that emergency fund, however. You may reach your goal of saving x dollars, but then feel the pull to divert it to investment or spending. I’ve found this really helpful blog that offers tips on how to protect your emergency fund http://blog.greensherpa.com/index.php/personal-finance/3-tips-to-protect-your-emergency-fund/

  5. Well said Tom. Emergency funds are essential. My wife and I try to keep a few thousand handy should those “what ifs” in life materialize. That said, I hope they don’t :)

    Cheers,
    My Own Advisor

  6. Andrew Hayes says:

    Good post. Quite often, people who don’t have an emergency fund see the idea of having to save up money as some form of punishment – after all, money put in a savings account and locked away is money that can’t be used to spend. Actually, it’s quite the opposite – having an emergency fund means that you do have room to breathe. You don’t have to completely panic if your car breaks down or if you lose your job or if you suddenly need to replace a hot water heater.

    It does not have to stay in cash either- you can use a part of it to put into diversified investments like stocks and listed property funds

  7. I do like this post however, I disagree with the idea of not having an emergency fund if you’re still in debt. It’s often those in debt who can’t get money if something goes wrong. After all, like you mentioned, if you’ve paid off your debt, there’s a very good chance that you’ll have a credit card or line of credit kickin around that you can tap into. And often, people have gotten so far into debt that while they still owe the money, their credit cards are no longer valid – and they won’t have one that is for another 5-7 years until they can re-establish their credit. Why not still save up an emergency fund, pay off your debt at the same time (yes it will take longer but being debt-free is a marathon, not a sprint for many) and still be protected in the meanwhile?

  8. Keith Guinchard says:

    I agree with Bryan. As a former CFP and then later a non- profit debt counsellor I saw both sides of the story. Focusing entirely on debt repayment without any emergency savings leaves you wide open for the next emergency. It can take years to pay off a large debt load and in the meantime life happens. Without any money set aside you end up using your cards again. The emergency fund does not have to be large, enough for example to cover a new water heater or car repair ($1,000).

  9. Am still in the process of starting off my emergency fund starting with the bare minimum of $1000 (As per Ramsey’s advice). I can certainly agree with you…its something you do slowly and steadily over time. I have taken on a side job to make the whole process a bit fast…its unnerving rolling minus an e-fund given that things tend to break when you least expect them to.

Leave a reply

Notify me of followup comments via e-mail. You can also subscribe without commenting.

Name: Email: