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. If you want to protect yourself in the even of financial setbacks, it's a good idea to have an emergency fund that works for you. From paying a high deductible on your insurance policy, to providing you with a way to pay bills if your hours at work are cut, an emergency fund can be very helpful.
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. Put 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.
Tips to Build a Better Emergency Fund
1. Start Small
Many of us feel overwhelmed when we listen to experts who tell us that we need nine months' worth of expenses saved up. If your expenses total $3,000 a month, that's $27,000 you need! Focusing on big numbers like that can be discouraging, and lead you to not set anything aside at all.
Instead, start small. Focus on what is doable right now, rather than the end result. Go through your budget, and determine how much you can set aside right now. Once you've done that, start putting it in an account. My wife and I both use the Tangerine TFSA, and you can get 2.4% interest for 6 months and up to $50 in bonuses through this link. Then consider ways you can increase what you set aside until you reach your goal.
2. Consider Accessibility
Your next step is to consider accessibility. You want to be able to get to your money when you need it. Tying it up in an investment account can be problematic, especially if you run into a true emergency that requires that you get your cash quickly. Sometimes, this means that you give up some of your return so that you can get to your money quickly. An account connected to an ATM card, or an account that is linked directly to a checking account with debit access, are good choices if you want immediate accessibility.
It's also possible to consider different types of emergency setups. You can keep part of your fund in an immediately accessible account, and then keep the bulk of it in an account that is a little harder to get to, but offers better returns. For instance, you can keep a smaller amount in the local bank, where you can use it immediately while you wait for a larger amount to be transferred from an investment account after you sell some assets.
3. Look for High Yield and Other Benefits
Now that you know which accounts are quickly accessible, it's time to try and get the highest possible return that you can. Unfortunately, savings accounts are known for low yields. When you have money that is basically safe, and easily accessible, it's not going to pay you a very high yield. You can turn to high yield accounts to help ease some of the pain, by giving you the best possible return for your money.
If you are building an emergency fund portfolio, with different types of accounts, you can create a GIC ladder for better yields. You can also consider a TSFA, which comes with tax benefits, as well as the possibility of better returns.
Make Sure You Can Access Your Money When Needed
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 would be a good choice, possibly within a TFSA if you have available contribution room. 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!
Start Your Emergency Fund Today
The best time to start was yesterday. The next best time is now.
That's one of my favourite quotes and it definitely applies here. Sure, you should have an emergency fund, and you may have even regretted not starting one yet. So why not start today? With a $100 deposit, you can get started with Tangerine and setup automatic savings with them. As a perk for taking action, you can get $50 in bonuses and a 2.4% interest rate, so open an account and protect yourself from financial disaster.