Having an emergency fund gives you peace of mind. Between paying off loans, covering everyday expenses and saving for the future, managing a budget can be a big challenge that doesn’t leave much wiggle room for the unexpected. While you can’t predict the unexpected, you can still prepare for it. And the best way to do that is to build up a little financial cushion so you don’t have to resort to credit every time.
What is an emergency fund?
An emergency fund, also known as a “financial” or “safety” cushion, is meant to help you deal with unexpected emergency situations.
You could use this financial reserve if your income is reduced because of a job loss or health problems. These funds can also cover immediate expenses when you don’t have the time or option to save.
Unlike annual purchases you can plan, such as regular car maintenance or back-to-school expenses, your emergency fund should be used in situations you often can’t avoid: an appliance breakdown, a leaking roof, dental care that’s not covered by your insurance or even an emergency visit to the vet.
Reducing your financial stress
When something unexpected happens, many people find themselves turning to different forms of credit with high interest rates that can quickly add up and put them in more debt. An emergency fund allows you to reduce that financial stress and keep from quickly finding yourself in a situation you don’t want to be in.
Credit is expensive
“Even though you can sometimes postpone certain payments and make temporary arrangements, it’s important to keep in mind that it can end up being expensive,” says Angela Iermieri, financial planner at Desjardins.
She recommends avoiding credit card cash advances, because the interest is charged when you take them out. You don’t have the 21-day grace period you get when you use your credit card to buy something.
How to save?
An emergency fund should cover from 3 to 6 months of basic monthly expenses. That includes rent or mortgage, groceries, phone and Internet and any financial obligations. Simply ask yourself, “If my income were cut by half, how much would I need to cover my basic expenses?”
That’s about $6,000 to $12,000 for someone who normally spends approximately $2,000 a month.
Develop the savings habit
Once you’ve determined how much you need to save, the best thing is to develop a savings habit by setting up automatic preauthorized transfers from your regular account to a savings account.
“It’s important to adjust the transfer amount based on how much you can afford and the frequency, so that is stays realistic and you can keep it up over time,” says Angela.
Planning your transfers
Practical tip: plan to coincide your automatic transfer with payday. Just set it and forget it.
Where to deposit the money: A dedicated account to save for the future
One of the benefits of opening a dedicated savings account, such as a tax-free savings account (TFSA) or high-interest savings account is that you can easily access it at any time.
Here are some helpful tips:
- Open an account separate from your regular one for everyday transactions
- Pay little to no transaction fees in your account
- Check to see if there’s any penalty for withdrawals
It’s never too early or too late to create an emergency fund, but the sooner you start, the more prepared you’ll be to face the unexpected.
In some situations, it’s recommended to get guidance and support, for example, to refinance your debt or get advice to reduce your expenses and develop good savings habits. Feel free to contact your Desjardins advisor if you have any questions.