Nobody likes to think about a rainy day.
I’m not talking about a real rainy day – that can actually be quite tolerable, with boots, a good umbrella and some hot chocolate and marshmallows. I’m talking about that other rainy day you’ve heard about, the one your mom said you should be saving for.
Whether you’re hauling in serious dough or just squeaking by, everyone should take a minute to consider what would happen if an unfortunate event came along and threw a wrench into your finances – a busted furnace, a pink slip, a family illness – and you found yourself facing a serious income shortfall.
If your answer is, “I’d put it on my line of credit,” “I’d borrow from my parents,” or “I’d be seriously pooched,” consider yourself in need of an emergency fund.
Canadians have become a nation of spenders instead of savers and as a result, most of us don’t have a nest egg built up, “just in case.” How much is enough? A good rule of thumb is that you should have three months expenses socked away (another theory is three months salary). That kind of reserve fund gives you at least a grace period to deal with your problem without sinking you into debt.
In order to get your emergency fund happening, follow these simple steps and feel like a responsible adult:
1. Check your balances. First up: your credit card(s). If you have a balance, tackle that before even thinking about starting an emergency fund. No point in paying 18 per cent interest any longer than you need to. Once that’s sorted, check your bank account balances. Do you happen to have several thousand dollars hanging around in your bank account with no place to go? If so, woo hoo! Good for you. You’re well on your way. Head right to step three. If not, don’t fret, you’re in good company. Go to step two.
2. Check your budget. This is an essential step for two reasons. First, you need to find out what your monthly expenses are so you can determine what your emergency fund amount should be. Second, you need to find out how much you can afford to spare monthly to start putting towards your emergency fund. Even if you can only afford a small monthly amount, that’s fine, at least it’s a start. (Keep in mind, though, if you’re only saving $25 a month, it’s probably going to take you an awful long time to build up three months’ expenses. And if you could stand to shave a bit off your expenses each month by cutting down on lattes/restaurants/clothes/wine/videogames/other assorted vices, it’s time to make some hard choices).
3. Set up a tax-free savings account. If you don’t have one already, a tax-free savings account (TFSA) is a great vehicle for your brand spanking new emergency fund. As of 2013, Canadian residents can contribute up to $5500 annually to a TFSA and the investment income earned is tax-free. Also, withdrawals are tax-free and you can carry forward unused contribution room in future years. Though you can use your TFSA to invest in products like bonds, GICs and mutual funds, your best bet for your emergency fund is a straight-up savings account, which will give you ultimate liquidity in case you need it pronto.
4. Set up a monthly contribution. You figured out how much you can afford to contribute in step two, so now set up an automatic monthly transfer into your TFSA. You won’t notice that extra cash dutifully leaping over every month, and it will start growing, growing, growing, until it creates a nice, fat emergency nest egg.
5. Relax. Once you’ve accumulated your goal emergency fund total, you can breathe a sigh of relief. You’ve covered your butt in case something crummy should happen, and it wasn’t all that painful, right? Plus, now that you’ve gotten used to that money coming out of your account every month, you can start contributing monthly to your RRSP. Or, set up another TFSA and start saving up for something big you want (like a fancy pair of shoes, a vacation, a new car, whatever your jam) instead of putting all that crap on credit first and paying it off at a later date.
Shelley White is a Canadian freelance writer, editor and TV producer who contributes regularly to The Globe and Mail, The Huffington Post, The Grid and Spinner.com. Shelley is also a mother of two who aspires to never again carry a credit card balance.