Three to six months’ worth of expenses set aside in an emergency fund? Yeah, right. More like three to six weeks’ worth…sound familiar? An emergency fund—a stockpile of enough money to pay for up to a half year’s worth of living expenses—helps prepare for life’s disasters, such as losing a job or becoming too sick to work for a while. Yet for many of us, saving that much money seems as daunting as learning how to whip up a perfect soufflé. After paying the bills and saving for retirement, who has that much extra money to save at the end of the month?
Relax. Here’s what you really need to know about building your emergency fund:
1. It’s not what you think: You make $50,000 so that would mean you need to save between $12,500 and $25,000, right? Wrong. Remember, you’re not saving the equivalent of your earnings for those months, just your expenses, and there’s a good chance you’ll be able to scale way back on what you spend while looking for work. So if you typically fork over $2,800 a month to pay for housing, food and utilities, you actually need between $8,400 and $16,800 in your fund. Not chump change, but it’s still a more manageable sum.
2. Lower on the totem pole: Looking at the sum above and still feel like hyperventilating? Here’s something to consider before building a small fortune in liquid assets: emergency funds are not as important as saving for retirement and getting out of debt. That’s because it makes no financial sense to pay 22 percent interest on credit card debt while your emergency fund, which will probably be socked away in a money market account or high interest savings account, earns a measly 1.5 percent. And don’t forget the magic of compound interest. If you were to take that $16,800 and put it into an RRSP, it will probably be worth way more by the time you retire. The only time saving for an emergency fund should trump all is if you see a pink slip in your future at work.
3. Have more than one: That’s right. It’s perfectly fine to own more than one emergency fund. Some people swear by their “if the furnace breaks fund,” a “holiday gift fund” or an “I can’t take winter anymore and need to get to Florida fund.” These situations, while not quite emergencies, come up all the time.
4. Another option: Some experts, like Rhonda Sherwood, a financial advisor in Vancouver, suggests clients set up a line of credit if saving for an emergency fund is a stretch. “The truth is, no bank is going to give you a loan if you’re out of a job, so if you already have a line of credit, you can live off that until you get back on your feet,” she says. One word of caution though: if you have trouble staying out of debt, this option is not for you. You’d be better off sticking as little as $20 a month into an account and watching your emergency fund grow over time.
Kira Vermond is a freelance writer and author of Chatelaine’s own Earn, Spend, Save: The savvy guide to a richer, smarter, debt-free life (Wiley, 2010). You can also listen to her career and money advice on CBC Radio weekday mornings across Canada.