Why you need an emergency savings fund (and how to start one)

How many months would you be able to cover your bills and expenses if you lost your job, became ill, or fell victim to some other unfortunate circumstances today?

If the answer is less than a month, you need to start an emergency fund.

While we hope for the best, life can change suddenly, and an emergency fund can help you stay on top of your financial obligations, reducing stress and giving you time to solve the issue at hand.

Below, I’ll explain why an emergency fund is so important and offer some simple tips on how to start yours.

What is an emergency fund?

The average Canadian under 35 has just $7,600 in savings, according to a 2019 report published by Statistics Canada. Here, “savings” refers to non-pension assets, including:

• TFSA holdings
• Cash in the bank
• Investments such as stocks and bonds

Depending on your living situation and monthly expenses, $7,600 could give you a few months’ worth of financial breathing room, especially if you live in a rural area or a smaller city. But this wouldn’t go far in a major city like Vancouver or Toronto.

It also assumes that the entire amount of your savings is in an emergency fund.

While saving money and investing in your retirement is always a good idea, everybody should also have an emergency fund that’s designated for emergencies only.

Emergencies include sudden and unexpected expenses, such as your vehicle breaking down and requiring costly repairs, sudden job loss, or a death in the family.

How much should your emergency fund be?

Similar to planning for retirement, the amount you need for an emergency fund depends on your lifestyle, income, and expenses.

Generally, I recommend having three to six months’ worth of expenses in your emergency fund.

For example, if your monthly expenses are $2,500, you should aim to save at least $7,500 in your emergency savings fund. If worst comes to worst, you’ll be able to maintain your current lifestyle and pay your bills for three months.

If this sounds like more than you can handle, don’t worry.

The important thing is that you start somewhere, even if it just means saving an extra $50 or $100 per week.

Simply having $1,000 in an emergency fund to pay for a costly auto repair can be a lifesaver, as it will help you get your car back on the road and ensure that you have reliable transportation to and from your job.

What should your emergency fund be used for?

It’s important to keep your emergency fund separate from your other savings. This means that it should only be used for absolute emergencies.

Your emergency fund should strictly be saved for unexpected emergencies that significantly impact your daily life and expenses, such as healthcare emergencies, sudden home/auto repairs, or to cover living expenses during unemployment.

How to build an emergency fund: 3 steps

Building an emergency fund really isn’t hard. It simply requires a bit of commitment and budgeting. Here are three easy steps to start your emergency fund.

1. Outline your monthly budget

First things first — you need a budget.

If you don’t have one outlined, I recommend using a free budgeting tool like Mint or Spending Tracker. Even a simple pen-and-paper budget can be a good place to start.

Go through your last month’s bank and credit card statements, and outline the following:

• Regular income
• Grocery expenses
• Gas/transportation expenses
• Car payment/insurance payment
• Utility bills
• Rent payment
• Subscriptions
• Uncategorized expenses (i.e., eating out, parking, shopping)

You can go deeper (which I encourage), but this should give you a good idea of how much you’re earning versus spending each month.

2. Determine how much you need

Next, you need to set a goal for how much you want your ideal emergency fund to be.

If you’re just starting out, set a goal to save three months’ worth of vital expenses. This would include your rent, utilities, car payment/insurance, and groceries while excluding non-essential expenses like eating out or unplanned shopping.

3. Dedicate a set amount to your emergency fund

With your goal set, it’s time to create an action plan to meet your goal. If your goal is to save $7,500, you’re likely not going to save it all at once or even in one month.

However, you could save $7,500 in one year by saving $625 per month, which is $156 per week and $22 per day.

To earn the extra $22 per day, you could ask your employer for some extra hours or consider picking up a side hustle like DoorDash, Uber, or SkipTheDishes for a couple of hours before or after your standard work shift.

If working extra isn’t your cup of tea, you could also find a way to cut back on unnecessary spending and dedicate the surplus amount to your emergency fund. For example, packing a simple, healthy lunch instead of eating out for lunch could easily save you $15 per day or more.

Choosing the right savings option

If you want to meet your emergency savings goal even quicker, I recommend saving your money in a tax-free savings account or a high-interest savings account. Both of these types of accounts allow your funds to compound over time.

Tax-free savings account (TFSA)

Most financial institutions offer government-regulated TFSAs. These accounts allow you to save money and can be used as investment vehicles to hold stocks, bonds, ETFs, or GICs. Unlike standard investment accounts, which require you to pay capital gains tax on your earnings, any profit realized in a TFSA is tax-free.

High-interest savings account (HISA)

High-interest savings accounts offered by smaller banks can pay you up to a hundred times greater interest on your savings than the standard savings accounts offered by big banks. The more you save, the quicker your savings will grow as the bank pays you interest.

Tapping into your emergency fund

Hopefully, you’ll never have to tap into your emergency fund. Realistically, though, you’ll need to draw on it from time to time.

When this happens, make sure to take note of every dollar you use and create a plan to replace it soon after the crisis. Additionally, you should adjust your emergency savings fund to account for increases in your monthly income and expenses.

Remember, it all starts with a simple budget and a plan. You got this!

Written for Daily Hive by Christopher Liew, a CFA Charterholder, former financial advisor, and the creator of Wealth Awesome.