An emergency, or rainy day, fund is money you set aside to pay for unexpected expenses. You’ll most likely have to deal with an emergency resulting from an unexpected situation or a drop in income at some point in your lifetime.
These surprises usually don’t give you time to adjust your budget.
Some examples include:
- car breakdown
- an urgent visit to the veterinarian
- job loss
- health problems that prevent you from working
Unexpected expenses should not be confused with occasional expenses such as back to school supplies, winter tires or holiday expenses. Occasional expenses should already be planned in your budget.
Setting up an emergency fund makes it possible to:
- handle an unexpected expense without getting into debt
- avoid high-cost loans (for example, a payday loan or credit card cash advance)
- have financial control
- have peace of mind
Tips to set up an emergency fund
Open a savings account
It’s important that you choose the right type of account to build your emergency fund. It should be easy to access your money quickly in case of an emergency.
Here’s what you should look for in a savings account:
- the account should be separate from the account you use for day-to-day transactions
- you pay no or low transaction fees
- you can make withdrawals without penalty
- you earn interest on the money you save
Consult your financial institution to make sure the account you have in mind will allow you to meet your goal to build an emergency fund.
Start by saving a realistic amount
It can take months, or even years, to reach the desired amount for your emergency savings. Don’t panic, this is normal!
It’s better to start with a small amount so that you don’t become discouraged.
Start by figuring out what you can put aside every week. Whether it’s $50, $20, $5 or some small change, the important thing is to start right now.
In general, it’s recommended that you save the equivalent of 3 to 6 months of your regular expenses. You can also aim to save 3 to 6 months of income. Both methods are effective, so choose whichever one works for you.
These amounts can sometimes seem out of reach. That is why you should save gradually.
Saving a small amount on a regular basis can make a big difference in the long term.
Figure 1: The progression of various savings amounts
The savings amounts in this example are for illustration purposes only. They don’t include the interest that you may earn or take into account any tax implications.
- at $5 a week, you’ll have $260 after a year
- at $10 a week, you’ll have $520 after a year
- at $15 a week, you’ll have $780 after a year
- at $20 a week, you’ll have $1,040 after a year
Make it a habit
Incorporate savings into your daily habits.
Here are a few tips:
- drop any loose change into a container every time you get home
- create a savings reminder on your smartphone or computer
- circle your savings dates in advance on a calendar
- put sticky notes in your wallet or on your mirror or refrigerator
Automate your savings
Choose a savings amount, date and frequency and then set up an automatic transfer from your regular account to your savings account.
Tip: set up your automatic transfer on the days you get paid so that the amount saved is transferred as soon as your paycheque is deposited into your account.
Eliminate an expense and save the amount
Eliminate some expenses and add these amounts to your emergency fund. Your current budget won’t be affected and your fund will grow faster.
To determine the expenses that you can eliminate, identify the difference between your needs and wants.
- Need: a necessity, an obligation, something essential
- Want: a desire, a wish, something non-essential
To eliminate an unnecessary expense:
- bring your lunch to work instead of buying it
- make your coffee at home and bring it to work
- use public transit instead of your car
- eliminate one non-essential food choice from your grocery list
- use discount coupons, cashback offers and take advantage of specials
Depending on your current habits, you could save a lot of money every day!
Review your goals
Review your financial goals on a regular basis. Your family, personal or work situation may change, and this may affect your budget.
Even minor changes can have an impact on the time you’ll need to reach your emergency savings goal.
These changes might include:
- a new child
- a new house
- an increase in your property taxes
- an increase in electricity costs
When these events occur, modify your budget accordingly so that your emergency fund remains a priority.
Increase your emergency fund
Take advantage of every opportunity that can help you increase your emergency fund. Deposit any additional amount into your savings account whenever possible.
For example, if you:
- get a tax refund
- get a pay raise
- sell something (for example, vehicle, jewelry, furniture)
- get money as a gift
- get a performance bonus at work
When you finish paying off a loan (for example, a car loan, a student loan or financing from a store), it’s a great opportunity to increase your emergency fund. Take the money you were putting towards your monthly payments and deposit them into your savings account instead.
These payments are already included in your budget, and this is a way to put the newly available money to good use.
Advice to help you use an emergency fund
Before using all or part of your emergency fund, determine whether you’re really experiencing an emergency or if the expense is something that can be put off until you’ve had the opportunity to save.
If you’re not sure, go back to your list of needs and wants. An emergency is a major and sudden need that’s not part of your current budget and that’s unplanned.
When it’s truly an emergency, don’t hesitate to use your emergency fund. It’s much better than costly options such as payday loans or credit card cash advances. The purpose of an emergency fund is to avoid resorting to these expensive options.
On the other hand, if you determine that you don’t have a major need, don’t touch your emergency fund. If you can use a credit card and pay the balance in full by the end of the month, this might be a good option. If you don’t think that you’d be able to pay it back in full, then hold off on that expense until you’ve saved enough.
While your emergency fund should be easy to access, it’s very important not to let yourself be tempted by this money and to leave it intact for a real emergency.