Beginner’s Guide to Building an Emergency Fund
As we have all learned this last little while, life is unpredictable.
You can get thrown a curve-ball, like a world-wide pandemic. Whether you experience a job loss, an unexpected car or home repair, or even a medical related expense, you can get caught off guard, and financially unprepared.
At the start of the COVID-19 pandemic, many people faced a decrease in income or even a loss of job, or business.
Having an emergency fund to fall back on or tide them over, eased the financial burden and allowed them to find another income source with less stress.
By choosing to keep an emergency fund, you are making a smart personal finance move.
It helps keep you on track and provides you a safety net, so the rest of your money can continue working for you, whether it is paying bills or growing in the market.
What is an Emergency Fund?
So what even is an emergency fund?
An emergency fund is not to be touched, except for unexpected emergencies.
This money can be accessed right away and is not locked up in the market.
An emergency fund is a pile of money that you keep aside to use only for emergencies.
Emergency funds are similar to that pile of money your parents or grandparents kept safe under the mattress. In modern times an emergency fund is kept in a bank account.
This money needs to be accessible quickly and easily with a transfer or withdrawal.
Why are they important?
An emergency fund acts as a safety net to help you stay away from putting emergency costs on your credit cards, or taking money from your long term savings, such as \ your retirement account.
An emergency fund should only be used in dire situations, such as:
- Loss of employment
- Significant decrease in income
- Major car repairs
- Major unexpected home repairs (not upgrades or new decor, that you can save for separately)
- Unexpected medical expenses (regular doctor and dentist appointments you should budget for)
- Major car repairs
A new wardrobe or last minute trip is not a good enough reason to use the money from your emergency funds account.
By having an account only used for emergencies, it offers protection both financially and emotionally.
How Much Should You Keep in an Emergency Fund?
To get started with an emergency fund, it is recommended by most experts to start with at least $1000 in an account.
This will help cover small unexpected repairs, such as a flat tire, new toilet or unpaid sick days.
As you can imagine incase of a larger emergency, $1000 will not last you very long.
That is why it is recommended to work your way up to having 3 -6 months worth of living expenses tucked away.
So if you spend $2,500 in a typical month, you would need to save up $7,500 for 3 months worth, and $15,000 for 6 months worth of living expenses.
That way if you get caught off guard with an emergency, you will be able to manage it financially for a short while until you get back on your feet.
How Long Does it Take to Build an Emergency Fund?
The time it takes to save up money for an emergency fund, can vary greatly depending on your financial situation.
You may not have $1000 just laying around to put into a separate account, let alone $15,000 or more.
Slowly but surely put aside any extra money be it $2, $5, $10, into an account.
Got extra change?
Got a wage increase or bonus?
Throw that extra money towards your savings!
Do not fret over saving slowly. Saving slowly is better than not saving anything at all!
Where Should I Keep My Savings?
As I mentioned before it is important to store your money somewhere safe, out of the way of temptation, but still easily accessible incase of an emergency.
It should be kept in an account separate from your checking account, that you use for day to day transactions, such as bill repayments.
You can store your money in a Savings Account, a High-Interest Savings Account (HISA), or even a Tax-Free Savings Account (TFSA).
Whichever account you choose it should have:
- Low or no transaction fees
- Penalty free withdrawals
- Earn you interest, to help keep up with inflation
The following is a breakdown of the pros and cons for each of the accounts to help you choose.
Savings Account
Pros:
- Easy access to your money
- Easy to open
- No fees
- No withdrawal limits
- Every bank offers a savings account
- No minimum amount needed to open an account
Cons:
- Low to no interest rate, meaning your money will lose value over time
- May be too easily accessible, and tempting
- Can get lost in the shuffle of your other saving goals
High-Interest Savings Account (HISA)
Pros:
- Interest rates range from 1% to 3% (allows your money to grow as it sits there)
- Most offer no fees
- Most offer unlimited withdrawals
- Most offer no minimum amount needed to open account
- Gaining popularity, so many banks or credit unions offer such an account
Cons:
- Inflation usually averages around 2% – rates are fairly low at the moment, so it may be hard to find a true, high-interest savings account
- Some HISAs limit the amount of money you can withdraw at one time (May not be that helpful if you need a lot of money for said emergency)
Tax-Free Savings Account (TFSA)
Pros:
- Money can grow tax-free
- Many banks also offer High-interest savings accounts inside of your TFSA
- Offered by all banks
- No fees
- No withdrawal limits
Cons:
- TFSAs have an annual contribution limit
- If you exceed the contribution limit you will receive a penalty
Feel free to consult with your financial advisor, as to what sort of account will work best for you.
* Please keep in mind, brick and mortar banks tend to push certain accounts, especially TFSA for emergency accounts, this may not be the best use of a TFSA, as they can be used to grow your money on the market long-term and tax-free. But it is an option.
Full disclosure: My emergency funds are currently divided between a regular savings account, and my TFSA. As I get more confident in investing in the market, I plan to rebuild my emergency account in a High-Interest savings account, and allow my investments to grow in my TFSA.
Where NOT to Put an Emergency Fund
- Do not put your emergency savings into an account that is not easily accessible
- Do not keep your emergency fund with the rest of your cash
- Do not lock it up in the markets, such as stocks, bonds or GICs
- Stashed in a jar, under a mattress or in a shoe box (money is more likely to get lost, stolen or damaged)
- Do not keep it in your regular checking or savings account
Why shouldn’t you keep your emergency fund money in your checking/savings account?
- You may end up spending it accidently
- Temptation of spending it on non-emergencies
- Money loses value due to inflation (that’s why it is good to earn interest on your savings)
How to Build your Emergency Savings Account
Start Small
As they say, every penny counts.
Saving up a large sum of money can be daunting, do not get discouraged, and put aside what you can.
Choose a small amount that fits into your budget, and set that aside regularly.
You can always increase the amount if you come into more money.
One frugal moment at a time and you will get there.
Cut Down on Expenses and Save the Extra
As you work through your budget, look for areas where you can cut back. Any extra money saved, you can put towards your emergency fund.
Examples of where you can easily cut back:
- Make your own coffee
- Bring your own lunch
- Skip the take-out and cook at home
- Walk or take public transit to save on gas
- Only buy essentials when you grocery shop
- Make simple meals that require low cost ingredients
- Cut the cable
- Lower your insurance
Automate and Pay Yourself First
Once you have chosen where you will be storing your emergency fund.
Set an amount and frequency (weekly, bi-weekly or monthly) and have an automatic transfer set up from your main checking account to your new emergency account.
I usually set all my automatic transfers on the days I get paid. So once my paycheque hits my checking account, all my other accounts get their share (emergency fund, retirement, investment, wedding), and I spend what money is left on my bills.
By automating your savings you are paying yourself first, and can not use the excuse of, “I’ll save if there is anything left”.
Stash Extra Cash
If you come into extra cash, such as:
- Tax-refund
- Wage increase
- Birthday money
- Bonus/Commission
- Rebate/refund
- Extra paycheck (For those of us who get paid bi-weekly, some months we get paid an extra check, stash the entire thing!)
By saving any of the above, you will increase your emergency savings, and not even miss it, as it was not normally in your monthly budget anyway.
Sell Your Stuff
Sell anything and everything that you are not using, or have duplicates of.
It is an easy way to make some quick cash that you can squirrel away into your emergency savings fund.
You can sell clothes, shoes, books, toys, old electronics, search your place and put it up for sale.
Host a garage sale, or list the items on sites such as Poshmark, Facebook Market Place, eBay, Amazon, Letgo and such.
Try a Spending Freeze
Stop spending for a week.
No shopping, no eating out, no spending any money.
Calculate how much you have saved compared to a typical week’s worth of spending, and transfer that money into your emergency fund.
* Warning, spending freezes can be hard, but stay strong and push through, it is worth it!
Replenishing After an Emergency
If you need to dip into your emergency fund, repeat the steps above as soon as you can to rebuild your account.
Do not feel disheartened that you used the money if it was a true emergency, that is what it is there for.
Wrapping it up
By living below your means, paying yourself first (with the help of automatic transfers), and storing your money in a secure, compounding account, you too can be on your way to a nice safety-net of an Emergency Fund.
By having an Emergency Fund account, you will be prepared for the next curve-ball life throws at you, and you will feel a sense of ease.
You got this, it will not be easy, but it will be worth it.
I’d like to hear from you,
Do you have an emergency fund?
How are you saving money towards it?
Let me know in the comment section below!
Stay frugal,
Connie xoxo
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