The Emergency Fund

How much to set aside depends on many factors

One of the most agreed-upon financial planning concepts is the importance of an emergency fund. Having quick access to money to pay for an unexpected expense can prevent unwanted credit card debt and can lower stress levels.

Not everyone is on board though. Some people believe that keeping money in cash instead of investing it means you’re sacrificing too much potential growth. Others feel that their home equity line of credit is their emergency fund. Although there is merit in both of these arguments, in general I’m a strong believer in the emergency fund. The trick is to find a balance between having enough money on hand while not sacrificing investment returns.

There are really two kinds of emergency funds: one that will pay your expenses if you lose your job or can’t work for a period of time, and one that will pay for the large, unpredictable expenses that crop up in everyday life. The key to figuring out the how much money you need in a super liquid, low-interest bearing account versus something you can put away to earn a little more interest is deciding how much money you could potentially need for each type of emergency – not an easy task.

The job loss emergency fund

Job loss can mean you were laid off or that you can’t work due to illness, an accident, or a personal/family crisis. You might have heard the standard advice that says you need 3-6 months’ worth of living expense to protect against a job loss. Like all personal finance shortcuts, this isn’t necessarily helpful. How much you need in an emergency fund is highly dependent on your situation.

Here are the main factors that influence how much you should have set aside in your job loss emergency fund:

1. Do you have job stability? If your industry is known for sudden layoffs or if your role might be considered non-essential to an organization, you have a higher risk of losing your job and it might take you longer to find a new one. It would be wise to have a bigger cushion than someone who works in a stable industry or performs an essential role.

2. Do you have disability insurance? If you have an accident or get really sick, you’ll receive some kind of payment while you have to take time off work. It won’t necessarily be enough but it will help and you’ll need a smaller emergency fund. If you expect to receive no pay if you need to take time off work, you need a bigger emergency fund.

3. What kind of lifestyle do you want to maintain? If you are laid off, you’ll need to pare back your spending. But to what extent? What do you consider to be “essential”? Are the kids’ swimming lessons essential? What about your gym membership? Understanding what essential means to you will help you decide how much to set aside.

4. Do you have a partner or spouse? If you have a partner or spouse with whom you share the financial responsibilities of running a household and they are employed, would they be able to cover the essentials if you lost your job? How would your lifestyle be impacted? What is their job stability like? Do they work in the same industry as you do? If so, there might be a higher risk of both of you being laid off at the same time.

5. Do you have savings in a TFSA or a non-registered account? If all of your money is in RRSPs or your pension, you don’t have any good options for withdrawing money in an emergency. However, you are able to take money from your TFSA in a dire emergency – there are no penalties and you can replenish the TFSA in the following calendar year. (Of course, if this money is earmarked for retirement, this will impact your retirement savings trajectory, which is something to consider.)

Large expense emergency fund

For your large expense emergency fund, the amount you want to have available depends on how many opportunities for unexpected expenses you are exposed to and what other resources you could draw on.

1. Are you a homeowner? Owning a home can require large outlays for repairs and maintenance. A few years ago my furnace broke down and I spent $10,000 on a new one (plus adding air conditioning). Need a new washing machine? Count on $1,400. Racoons nesting in your roof? $1,000. (It happened to me.) Deck rotting? Leak in your bathroom? You get the idea. This list goes on and on. And that’s not to mention improvements like painting, upgrading the bathroom, and replacing the cracked concrete walkway.

2. Do you have dependents? Children are the primary dependents in our lives and they present a huge opportunity for unexpected expenses. Braces, glasses, stolen bike, malfunctioning laptop, lost phone, therapy or counselling…need I go on? Or maybe you have parents who wouldn’t be able to afford things like homecare if they suffer a stroke, or renovations to adapt their house due to mobility issues. Having people counting on you to pay for their needs makes a big difference.

3. Do you own a car? We all hate that sickening feeling in our stomach when the mechanic gives us the estimate to fix the car. The feeling is worse if it stays on your credit card for months on end. Unless you have a very new car, expect that you could be hit with a big bill at a moment’s notice.

4. Do you have a pet? Vet bills are another stressful event and they can add up quickly, especially if your cat or dog gets injured or sick. Plan for several thousands of dollars should your furry baby get in serious trouble.

5. Do you have a cottage or other property? Sometimes bad things happen at the cottage – broken windows, downed trees, burst pipes, a runaway dock. It can be hard to know what might happen next, especially if you rent it out.

6. Do you have a home equity line of credit or TFSA money? Although traditional financial advice says that you should never count on using debt for emergencies, for some p

ople it’s fine. If you earn enough money that you’d be able to repay the line of credit fairly quickly – within a few months – then the interest expense you’ll pay might be lower than the opportunity cost of leaving money in a savings account instead of in the stock market. You could also use funds in your TFSA or use other non-registered savings. However, if this money is invested in the stock market, you might not want to sell anything if the market has taken a dip.

Everyone’s emergency fund needs are different and it can be hard to know what the right amount is. If you keep in mind the two desired outcomes of having an emergency fund – staying out of debt and reducing stress – you’ll probably be able to find your own personal number.

The next blog post will go into more detail about how to decide how much to set aside and also what do to with the savings until you need it.