If the past year has taught us anything it's that emergencies happen, and the need to protect yourself and your family has never been greater. Emergency funds are a layer of security between you and the debt that can and will accumulate when financial hardships occur.
Losing your job, suffering from an unexpected illness, and major car or home repairs are common reasons the average person begins to fall behind in payments. Emergency funds help us stay afloat, but few of us know how much we should be saving.
While the exact ideal savings amount you should be saving is up for debate and will vary per person, we've put together a guide to help you discover the amount that is achievable and will keep you from stressing about your finances.
What Is an Emergency Savings Fund?
Put simply, an emergency fund is a separate stash of money from your savings account that you've set aside for the sole purpose of helping you navigate unexpected expenses.
Most of us never saw the global pandemic coming and didn't have time to prepare in case of medical expenses, potential unemployment, or rent/mortgage payments. Without an emergency fund to fall back on, you may have to rely on high-interest loans or credit cards to cover these costs.
Don't panic! There's good news ahead. One of the best ways to prevent debt is to open your very own emergency savings fund. After all, it's always better to plan for the worst just in case you have to battle another year like 2020.
How to Save for an Emergency Fund?
You know you absolutely need an emergency fund, but what now? Where is this money going to come from? Are you going to be struggling just to create this emergency fund? Take a deep breath and don't worry.
Few people have the extra cash to throw around to open an emergency fund with sufficient amounts of money to keep a person afloat for prolonged periods of time. There should be a method to your saving. Use the tips below to gradually create an emergency fund that won't leave you feeling financially unstable while you build it.
Analyze Your Finances and Set Clear Goals
First, how in the world do you go about building this fund? The first thing you need to do is analyze your finances, so you can know how much you spend each month on essential and non-essential items and services. This will give you an overall summary of your finances and assist in determining your yearly costs of living and how much you're earning.
Once you have a clear picture of your finances, you need to set a goal for the amount you want to set aside. Financial advisors typically tell their clients to abide by the 50/30/20 rule where 50% of your total income goes towards needs, 30% towards wants, and 20% towards your savings.
Broken down further, of the 20% of your income you put towards savings you should save between 5-10% of that total for an emergency fund.
Putting money towards a fund like this can seem like a non-essential expense, especially during uncertain times. However, saving during times of uncertainty provides an added layer of security and should never be overlooked.
Tips for Building an Emergency Fund
Below are some quick and simple ways to make building your emergency savings fund free from complications.
- Use an emergency savings calculator if doing math makes you want to run for the hills
- Set monthly goals for how much you want to save
- Authorize automatic payments into your account to prevent lapses in deposits
- Deposit your tax refund as a way to quickly bolster your savings
- Set clear boundaries on what constitutes an emergency and only use your emergency fund for those circumstances
Something is always better than nothing when it comes to preparing for an emergency. Reducing the amount you save from each pay cheque is okay, but you should make it a habit to always deposit something, even if it's just a few dollars.
If your income changes, you'll need to analyze your expenses again to recalculate how much you can easily afford to set aside for emergencies. It might seem tedious at first, but it can mean the difference between crippling debt or financial freedom.
What Is the Ideal Savings Amount?
The ideal savings amount will vary widely depending on your current financial situation. As a rule of thumb, it's best to save three to six months of expenses. It's important to note that this is not three to six months of your total income, but just your expenses that you've already calculated in the steps above.
You don't need to add the entire amount at once, but it does give you a figure to aim for and allows you to prepare if the worst does occur. That way you'll know you're covered for at least a quarter to half a year without having to worry.
The following are circumstances in which you should consider adding more to your savings fund as an extra precaution.
- You're a single income household
- The economy is in recession
- Your income is heavily tied to the economy
- Your income isn't steady
- You work in a high-risk industry
- You have multiple dependents
Drawbacks of Adding Too Much
While there is no such this as being too prepared when it comes to your finances, adding too much to your emergency fund can potentially be harmful. There are two major drawbacks to adding too much money to your emergency fund.
More on this later, but financial experts agree that emergency savings funds should be placed in a low-risk savings account where the interest rates are typically low. However, putting too much in this type of fund reduces the funds available for higher-earning savings or investments.
It's all about balance. Calculate how much you need for an emergency and deposit until you reach that goal. Once you've established your emergency funds and feel confident you're ready for whatever life throws at you, then you can focus more on investing your money in places with higher returns.
Secondly, if you neglect other methods of saving accounts, you can miss out on tax breaks. RRSPs should receive just as much attention as your emergency savings. Let's say you invested $10,000 in your emergency fund in a normal savings account with 2% interest. You would earn $200. However, if invested in an RRSP you could earn 3-4 times that amount.
These type of accounts are higher risk than a savings account, but they are not high risk by any means and are commonly used for retirement savings plans.
Discovering the ideal amount to save in your emergency fund takes time and balance. You may find yourself adjusting that number on a monthly or quarterly basis depending on personal or economic circumstances and that's okay.
If in doubt, consult a professional financial advisor or shop around to find the bank account or solution that best suits your current needs.
Best Place to Keep Your Emergency Savings Fund
You might be tempted to stash your funds under your mattress, but let's be honest, that's probably not the best option. As a general rule, your emergency savings fund should be safe from risk, easily accessible, and able to earn interest.
Sorry mattress money stashers, those parameters make this option a no-go. Hiding money in your home or car leaves it vulnerable to theft and doesn't provide an opportunity for it to earn interest. It's also way too easy to spend that money for non-emergency expenses when it's just laying around.
Luckily, there are much better places to keep your emergency savings fund. Your lowest risk options are a savings account and a TFSA account.
Benefits of Using a Savings Account
Wouldn't it be nice to know your money is safe and easily accessible both online and at a brick-and-mortar bank? That's what it's like when you use a chequing or savings account at your preferred bank.
While you won't earn a significant amount of interest, you can rest assured that the account will grow on its own over time. To maximize your earnings, open an account that has at least a 1-2.5% interest rate. Keep an eye out for minimum balances to ensure you won't be charged if you need to use those funds at a moment's notice.
When it comes to interest rates for a savings account, EQ Bank's Savings Plus Account offers one of the highest interest rates, up to 1.50%*, on the market. This account makes saving funds quick and easy by providing a program to set and track your savings goals. No monthly fees, no minimum balances, and free day-to-day transactions allow you to build your fund without fear of overdrafts or unexpected fees.
You might already have a chequing or savings account and be tempted to simply add funds to that with the intention of using funds for an emergency, but this can quickly turn into a tangled web of confusion.
It's best to compartmentalize your funds by their intended purpose to ensure you don't accidentally spend your emergency fund on a fun night out. Having several accounts might seem complicated but it keeps your finances organized.
Each account should have a specific purpose so one account is for emergencies, while another is specifically for activities like travel, and another is dedicated to your day-to-day expenses.
*Interest is calculated daily on the total closing balance and paid monthly. Rates are per annum and subject to change without notice.
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Benefits of Using a TFSA Account
Your second option is to open a TFSA account which stands for Tax-Free Savings Account. It serves as an investment account where you add money and watch it grow. You have the option to add cash or you can choose to invest the money you add in mutual funds, bonds, or stocks to (hopefully) see a greater return on your investment.
What makes it different from a savings account you ask? Besides the ability to invest in the stock market within the account, the biggest benefit is not being taxed on the money you take out. You will be taxed on the money you earn and then subsequently place into your TFSA, so you won't be taxed when you withdraw funds.
There is one drawback to this type of investing; there's a limit to the amount you can deposit each year. This is called a contribution limit and the amount tends to fluctuate each year but hovers around $6,000. If you deposit more than the contribution limit you will be fined 1% of the excess deposit amount every month until the funds are withdrawn.
If you're looking for an option that has the potential to earn you more funds at a faster rate, the TFSA is your best option. However, it's essential you keep detailed records of how much you have in your account to prevent excess contribution fines.
Need Help Finding the Best Bank for Your Needs?
Setting up an emergency fund with the ideal savings amount can seem like an overwhelming process. There are multitudes of ways you can choose to save your money, but it's okay to take your time with your decision, especially where your finances are involved!
Reference this guide as often as possible or use our blog to answer any other questions that you may have when it comes to making an informed decision about opening a new account. Do you already know which option you would choose? What are you waiting for, go get your emergency savings fund started today!