The Emergency Fund: Your Insurance for Everything Else
On most financial planning checklists, insurance is a pretty high priority. After all, financial planning is about mitigating risks. Chances are high that you carry some insurance -- car insurance, home insurance or maybe tenant insurance, and life insurance. (And if you don’t, KANETIX can help you get it all sorted it out.) But what about life’s other risks?
Enter the emergency fund.
Personal finance gurus love telling people how much money they should sock away in case of emergencies. Three to six months’ worth of expenses. So many thousands of dollars. These are arbitrary numbers that don’t help people understand why they should have an emergency fund, or how they should use it.
First of all, let’s talk about what an emergency fund is not. If you get into a car accident, or your roof caves in, or you are suddenly unable to work, an emergency fund isn't the answer. Remember: such risks are why you have car, and home, and disability insurance. Similarly, if you lose your job, an emergency fund is a mere partial answer because it will likely "top up" employment insurance. But an emergency fund isn't a long-term solution for unemployment. It will eventually run out. Your best bet for mitigating unemployment risks is to keep your skills up to date, maintain your professional network, and take advantage of every opportunity to expand your work experience. These things improve your job security and will help you find a new job.
So, what 's the purpose of an emergency fund?
The answer is: all of life’s little risks we tend to forget... until they actually happen, that is. The washing machine breaking down. A special assessment on your condo. A family emergency that requires a last-minute trip across the country. In an ideal world, none of these things would happen and certainly never at the same time. But they do happen. And it's when they do happen an emergency fund takes the financial stress out of the situation. Such situations are never fun but a well-stocked emergency fund can keep your finances in the black.
How much money do you need to have in your emergency fund?
There is no absolute answer; it depends on the risks you face. For example: a BMW windshield will cost more to replace than a Ford one. The more stuff you have, and the nicer it is, the more risk you need to consider. Ditto for family members; kids are expensive. Ideally, an emergency fund will allow you to deal with at least a few routine risks at the same time (after all, bad things usually happen in threes, right?). The dollar number will depend on each individual situation.
If you’re balking at the idea of tying up a serious chunk of money into an emergency fund, think about this: an emergency fund doesn't mean that your money must languish in a taxable savings account. Just make sure it’s liquid and readily accessible (e.g. not locked away in a registered product). Tax-Free Savings Accounts (TFSAs) are a great destination for your emergency funds, so long as you're careful to avoid over-contributions.