Life can be uncertain. Whether it’s a job loss, a major repair on your home or car, family emergencies, or a natural disaster, all of these could strain your finances – sometimes at the worst possible time. That’s why it’s important to have an emergency fund that you can fall back on.
Unfortunately, many people still don’t have an emergency fund. According to a survey conducted by Maru Public Opinion, only 62% of respondents thought they had enough money to cover an unexpected expense over the next two months. But since life is full of surprises, you can only benefit from having an emergency fund.
Typically, we recommend your emergency fund be at least four months' worth of expenses. You can figure out how much you should aim to save by adding up all your committed expenses, which are expenses that are the same every month and could be automated (e.g., rent, insurance, utility bills), and your spendable expenses, which are expenses that vary each month (e.g., groceries, entertainment, clothing). Then, multiply the total by four and that's a good amount to start saving up towards.
The best way to put money aside for emergencies is to open a savings account dedicated to your emergency fund, and set up an automated monthly payment to transfer a portion of your income to that account. In our app, Winton, we have a calculator that can provide you with a recommended amount to save for emergencies each month. Winton is an invite-only application that you can get through a financial professional, employer, or institution, and it provides financial literacy eLearning and financial planning tools.
Want to learn more about emergency savings? Watch the Financial Capability Series: Saving & investing
Here are five ways an emergency fund can help you keep peace of mind.
1. You’ll avoid high-interest debt
If an emergency comes up that you do not have the funds for, you might have to resort to debt to cover the expense. Your first thought might be to use credit cards or a line of credit, but if you don't have either, you might even consider taking out a payday loan. Either way, these all come with interest costs that can add up, especially if it takes you a while to pay the debt off. Payday loans in particular can be expensive, with interest costs ranging from 390% to 780% annual percentage rate (APR) in Canada, according to Finder.com. It may also be easier to spend more on the emergency when you use credit, as it’s quick and easy. When you use the money in your emergency fund you worked hard to save instead of credit, it can help you avoid overpaying to cover those unexpected expenses.
2. Your credit score won’t be affected
If you must use debt to cover the expenses of an emergency, you must also be aware that this could affect your credit health if you get too close to your credit limits. One of the biggest factors that are considered when calculating your credit score is your credit utilization rate. Your credit utilization rate is the amount of credit you are using divided by the total limit on any revolving debt (credit cards or lines of credit). If you need to use credit to pay for a big expense, your balances could climb too high, and your credit health could take a hit.
3. You won’t add to your financial stress
Finances are a big stressor in many people's lives, and things can escalate when an unexpected event requires you to spend money. Having an emergency fund can help alleviate some of the financial stress because you will have the peace of mind knowing that you already have some savings to cover the potential emergency. You also won’t have to worry about how long it's going to take you to pay off credit card debt accumulated by covering an emergency. And if you have an emergency fund, you may not have to change your lifestyle and regular spending habits to make up for the emergency expense.
4. You won’t need to ask family and friends for big favours
If you don't have an emergency fund or the option to use credit, you may have no choice but to ask family and friends for help. Many people may not like asking to borrow money, even if they know their friends or family would be happy to help. And sometimes borrowing money can cause strain in the relationship. It could be because you're unable to pay it back right away, so it puts a dent in the lender's savings. Or it could be because they are concerned about your financial situation. Having an emergency fund ready for unexpected expenses will allow your friends and family to better support you emotionally during that time, instead of having the extra tension of lending money.
5. You can still save for short- and long-term goals
By adding a bit to your emergency fund automatically each month, you can also continue saving for both short- and long-term goals. When an emergency does come up, you will have the funds ready for it and not have to worry about dipping into your other savings, like your vacation or retirement savings. And you won’t have to stop adding money to your savings accounts so you can keep up with debt payments caused by the emergency.
By regularly saving in an emergency fund, you will be saving yourself from potential financial strain in the future. Without it, you could be left vulnerable to all the unexpected events life might throw at you. If you’re not sure how much you should be saving, or where to find the money for an emergency fund, try reaching out to a financial professional, such as a Certified Cash Flow Specialist. This professional could guide you in the right direction to build a strong financial foundation so you’re more prepared and less at risk for financial strain.
CacheFlo is a financial education company that builds eLearning and tools to help financial professionals and individuals make behaviour-based changes, which allow them to get more life from their money. We want to make it easier for people to predict the impact of their financial choices before they make them.
About the Certified Cash Flow Specialist (CCS) program
CCS professionals go through enhanced cash flow-based training to develop the skill set to deliver behaviour-based cash flow advice. They start the financial planning process with a cash flow plan to genuinely help their clients get more life from their money.
About the Financial Capability Program (FCP)
The FCP combines quick and practical lessons with tools, including Winton, which helps people make financial changes they can stick to. Users can apply what they've learned to their financial situation, thus bridging the knowing-doing gap. The goal of the FCP is to help people get more life from their money.