All these reasons, although have a dangerous sense of validity, are excuses. The only decent excuses for not saving for an emergency fund are:
- You already have an emergency fund
- You don’t have income
- You have just enough income to meet your bills for survival
The first excuse is not an excuse because you already accomplished the goal. The other two are different problems altogether that need to be addressed urgently by either looking for a job or searching for additional streams of income.
The fact is life happens. Whether we like to admit or not, we’re not invincible and we cannot avoid the vicissitudes of daily living and the haphazardness that comes with it. For example, as I am writing this, the whole world is experiencing the covid-19 pandemic. This has had a drastic effect on the quality of life for people. Job security is gone for businesses and individuals alike.
Most people are already struggling. They have enough income to last them maybe 2 weeks to at most a month until they are out on the street. If you have no income because of illness or recent unemployment, you will not be able to meet your financial obligations, which could potentially result in disastrous outcomes including losing your home or losing your car etc. Government provisions or employment insurance should be looked into in situations like this.
However, chances are, if you are reading this, you wish to take complete control of your financial lifestyle. You probably want to be financially secure and achieve all your dreams. This starts with a solid 6 month emergency fund that covers your non-discretionary expenses. Let us define the term non-discretionary. Non-discretionary expenses are expenses that are a must i.e. your food, electricity bill, mortgage, rent etc. It can be a little tricky because a non-discretionary expense is relative to an individual. As we already discussed time and time again, financial planning is tailored to each individual. It is NOT a one size fits all. So, to some people non-discretionary might be gym payments because their health is a priority. It could be having a coffee every morning. However, there are ways that can allow us to manage these non-discretionary costs in a way, so that we’re saving money. For example, instead of paying for a gym, one can workout at home. Instead of buying a coffee every morning, consider purchasing a coffee/latte machine and preparing everything you need the night before so that all you have to do in the morning is mix your drink. We discuss this more in our other blog “how to squeeze every penny and shop efficiently”.
How do we start? Make a list of your non-discretionary expenses. Once again these are expenses that you absolutely must meet. Add the dollar amounts all up and multiply the total by 6. I can already hear some of you say, is it okay if I only have 3 months? Yes, any amount is better than no amount. The important thing is to start! Start now and keep starting every time you fall off the wagon. If you find yourself forgetting, start saving again and eventually you’ll have more and more which will encourage you to save more and more. Ideally, if you can save 12 months worth of expenses, that would be outstanding! Imagine what a 12 month emergency fund would look like; that means you can take 6 months off to go travel and still be financially secure. That, my friends, is peace of mind.
One of my best friends asked me, “what if I have credit card debts, should I save for an emergency fund first or pay off my debt?”
“what if I have credit card debts, should I save for an emergency fund first or pay off my debt?”
That is a conundrum. You see, if you don’t pay off your credit card first, you’ll accumulate interest. The more interest, the more money you have to pay that you could have set aside for your emergency fund. The answer to this conundrum is that it depends. You’d be best to consult a financial planner to elucidate your situation. That being said, let’s take a deeper look. The first question is how big is this credit card debt? Is it a small amount that you can take care of immediately? If it is, pay it off. If it’s a larger debt, ask yourself if it’s possible to consolidate it into a home equity line of credit (HELOC) or an unsecured line of credit with a lower interest rate than your credit card. The next point is where different advisors have different opinions. It is really a case by case basis. Some advisors would argue to take care of the credit card first so that you’re not stuck with the debt when you have no income. Although that would be fantastic, I think the reality is a little different. Some people have extremely large credit card debts. My advice would be to first determine how soon you want to pay up your credit card debt. Determine a payment plan. Next allocate funds towards your credit card payment and your emergency fund until you have 3 months worth of an emergency fund. Include in those funds, the payment toward your credit card. After you have saved at least 1-3 months worth of an emergency fund, you can then focus on clearing your credit card debt. Once that is cleared, you can refocus on saving toward your emergency fund. Once again, the best thing to do is to discuss it with a financial planner. Only then can they get a clear picture of your situation and tailor the advice.
Here is why an emergency fund is so important. Hospitals have back-up generators. Cars have seatbelts. We wear helmets when we ride our bicycles or motorbikes. So, while it’s true that you can take the risk…the question remains why would you risk you and your family’s well-being when you don’t have to? Peace of mind is priceless, strive for it. Start building your emergency fund today. Do yourself a favour right now and sit with your significant other and write down all your non-discretionary expenses or schedule a time to do it, if now is inappropriate. Remember, this is personal, so what is non-discretionary can vary from person to person. Some people need to hit the gym others need to eat take-out once a week for their sanity. Add up the total and multiply that by 6. That’s your goal! Take that amount and divide it by 1-48 months, which is your saving’s period. I recommend you start with something you can manage so that it is not too difficult, if that means increasing your savings period over 48 months, do it! Just get started. As you get more acquainted, then you can start increasing the amount and shorten the saving’s period.
Great, so now we’ve established that you need an emergency fund. We now know how much money we need to save and for how long. All that is left to ask is where will we be saving this money? Remember my blog on Canadian Investment Vehicles? The best place to build an emergency fund is in your Tax-free Savings Account (TFSA). That way, if you withdraw money, you pay no tax. Remember the TFSA is just an investment vehicle. It is NOT an investment. There are a number of investment options that you can choose, so which one is ideal? You want something safe and liquid. Liquid means you can access the money easily. Your home is not liquid because you need to sell your home to access the money. Cash is very liquid because all you have to do is withdraw it from your ATM machine. You cannot for instance put your emergency fund in a locked-in GIC because it will take away its liquidity. Also, putting it in a stock that is volatile could result in you losing that money. The best option is a high-yield open-savings account or a money-market fund. The interest won’t be superb in either one of these options but that’s the price you pay for security and liquidity. Remember, this account is for a very specific goal. So do not go on spending money from it unless it’s for an emergency. Discipline yourself to keep at it and only use it in an emergency.
As always, may you live healthy and prosper!