How Saving an Emergency Fund can Help You to Never Live Paycheck to Paycheck Again
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When it rains, it pours. I mean, most days are peachy keen. But then a rock hits your windshield, or your bikes just got stolen from your garage. Or you get news that a family member has fallen ill. Just to top it all off, you experience an unexpected temporary layoff from work. Will it ever end?
Now we all hope life will go according to plan, but we would be kidding ourselves if we thought unexpected costs don’t turn up now and then. Let me explain how saving an emergency fund can help you to never live paycheck to paycheck again. Not only will it keep you feeling more financially secure, the peace of mind it will provide is priceless.
What is an Emergency Fund?
An emergency fund is a savings account that you keep so that you have cash on hand in case of an emergency. To start, you may have a modest emergency fund of $500, say, while you are working to pay off credit card debt. Once your finances are in order, you will use your emergency fund to build a savings to a value that could cover months of expenses. This is personal to you, but this is generally how an emergency fund progresses.
The over-arching goal is to have your emergency fund be there for true emergencies, like if you need to travel to visit a family member who’s health is declining, or to pay for an unplanned medical expense. Those are real emergencies. However, everybody goes through a transition where you just need a bit of a buffer to keep you from going further into debt while you figure out your financial situation. For example, if paying off credit card debt is on your to-do list, an emergency fund will still be essential to prevent from adding to your credit card while you are trying to aggressively pay it down.
What an Emergency Fund is NOT
An emergency fund is top priority and would be the first step to getting your finances in order. However, in the long run, you would have different tactics to address other financial considerations.
For example, keeping a cash buffer in your main bank account prevents you from going into overdraft, and worrying if you have enough money in your account. Or implementing sinking funds to help you pay for large irregular purchases or bills. Think car repair, annual insurance, or holidays . These would ideally be paid for though a sinking fund so that your emergency fund can get you through real emergencies.
How an Emergency Fund can Help
So a couple crappy things happen to you in a row that cost money. You have to get your windshield replaced, you eventually have to replace your stolen bike, but that’s on hold because you just got laid off from work. Emotionally, this is rough. But now you have to figure out how you’re going to fund your life with no job for at least a little while.
This is where the emergency fund comes in. Without it, having to replace a windshield sucks. You won’t get your bike replaced because you couldn’t afford insurance for it, and its not the worst of your concerns right now. You don’t have a job and rent is still due. Without an emergency fund, you rely on what you have not spent yet from your previous payday, and…credit cards. Or some other form of borrowing money. Being in a position where you rely on your credit card, knowing very well you might not be able to pay the balance at the end of the month, is bad news. Credit Cards typically carry a significant interest rate (8-25% interest) and it compounds the longer you hold a balance, making it near impossible to get out from under. This perpetuates debt and maintains a poor financial position. You will never get ahead if you put yourself in a position where emergencies need to be paid with a credit card. This is not to say that a credit card can’t be used if you can pay your balance at the end of the month.
Why You Need an Emergency Fund
You need an emergency fund because stuff will happen that will cost you money, and you need it to not derail your finances (and your life) every single time. You can plan for some expenses with sinking funds (think annual car insurance or holidays), but emergencies happen. It’s nice to have some cash on hand so you can make it through the up and downs of life.
Your laptop dies mid-term, a family member falls ill and you have to buy a plane ticket to spend time with them, your hot water tank brakes, or you lose your job. These things can be a big deal. Or, they don’t have to be. I’ll come out and say that mindset is so important. You need to reflect in a given situation to realize what you have control over, and what you don’t. Otherwise you’ll be moping around for days. You’ll be even more upset if you can’t afford these recent events, and have to live off a combination of your most recent paycheck and your credit cards. You need an emergency fund for two key reasons:
- to help finance emergencies and unanticipated expenses, which provides financial stability and will help you stop living paycheck to paycheck; and
- for peace. You need to be able to live your life and focus on what matters rather than stressing out that you need more money.
Also, by having an emergency fund, you have a dedicated fund to pull from in case of unforeseen circumstances. This means that your cash flow should be predictable so you can begin to set up your cash buffer, and other savings. Goodbye living paycheck to paycheck.
Starting to Save for Your Emergency Fund
There are many different opinions on how much your emergency fund should be. I’m of the stance that something is better than nothing, to start. At least if you have something set aside ($250, $500, $1,000) than you are improving your finances. As long as you are going in the right direction, you should be able to build momentum and continue to improve. I would say start with $100, then go up from there as you can. If you’re just getting into sorting your finances, I would say once you have $1,000 set aside, you can start looking at other ways to improve financial stability. For example, by setting up your cash buffer and sinking funds.
Is there an Ideal Amount that an Emergency Fund Should Be?
Once you’ve got your finances generally on the right track, I would bump that emergency fund to $5,000. You will need to asses your situation from here. If you’re reading this, you survived the COVID pandemic. Scary times…but think back to how secure your job was (or wasn’t), or how well you were able to pivot your business during that time. Many people don’t feel secure unless that have 3 months, 6 months, or 12 months worth of expenses saved up. This is a bit much for where I am at in my life. We tend to keep $2,000-5,000 in our emergency fund BUT this is only because we have access to our sinking funds and TFSA investments should a more expensive emergency happen. Some people own rental properties or businesses they need to pay for in the event something should happen. I can imagine with this type of situation, you might want lot more saved up. Everyone’s comfort level is very personal to their situation. How much would you feel comfortable with?
In my opinion, the important part is that you have access to enough cash to float you for a little while without having to rely on a credit card (when it can’t be paid off in the same month).
Once you have your finances sorted, no consumer debt, and are paying as much as you can into your retirement fund, then I think it’s time to bump those emergency savings up to 3 months expenses, or more.
Action: Define the ideal amount for you to keep in an emergency fund, and commit to starting to put some money away toward that toward that goal.
Where Should you Put your Emergency Fund
You want to keep you emergency fund liquid, meaning in a savings account rather than invested. Ideally, you will keep your emergency fund in a high-interest savings account. You may want to keep a couple hundred dollars cash in the house so you can have it on hand should you need it, but you need to let your money collect interest so it is more protected against inflation. I personally only keep about $50 at home in cash.
I recommend using EQ bank for the highest interest rate, a free cash bonus to sign up, and because is it online exclusive. This means you can set up your automatic recurring payments to fund your emergency fund, but it would take a day or two to withdraw your funds, which prevents spending it. I have found that Tangerine and Wealthsimple offer higher interest rates as well, but not ever as high as EQ bank, which has been consistently the highest, in my experience. You can get $20 for signing up with EQ Bank today.
The point of the emergency fund is for that cash to remain liquid, so you can access it. This ensures that you aren’t put in a position where you are relying on credit cards to fund your life.
Can I Invest my Emergency Fund?
Once you have saved a decent amount of money in your emergency fund, you may want to re-evaluate your strategy to invest a portion of it in a short-term, low-risk investment. For example, when my emergency fund is fully-funded, I will be investing a portion of it in Guaranteed Investment Certificate’s (GIC’s) on a rotation.
I will probably always keep 25% of the full amount available in case of an imminent situation. However, I would split the remaining 75% of my fund into thirds, investing each third so that funds would be released on a fairly frequent basis. For example EQ Bank offers GIC’s ranging in interest rate depending on the length of time they hold your funds. So if I have a $20,000 emergency fund, I would probably invest $5,000 in a 3 month GIC, and then the same amount in a 6 month and a 12 month GIC account so that funds are always being released every few months in case we need access to them.
How Having an Emergency Fund Allows you to Take More Risks
The larger your emergency fund, the more confident you feel. By having a year of financial runway, you begin to feel more comfortable with being able to take risks such as changing where you work, building a long-awaited business, or deciding to take some time off to pursue your passion while you are still young, and enthusiastic.
Now that you are feeling more financially secure, it’s a good time to revisit your passions. Have you been wanting to start a small business that you think would bring you joy, and potential success? Maybe you feel secure enough to try it out. Maybe you even have the capacity to take a week off your regular job to pursue this passion. Because you are financially secure, you have a confidence to do this. Maybe you become pregnant and decide you don;t have to go back to work, based on your income and emergency fund.
The Value of an Emergency Fund
If you don’t have an emergency fund, you make yourself vulnerable by relying on your credit card for unexpected costs, like car repairs or last minute travel. Start with $1,000. If you can have that money as backup, emergencies no longer feel like such a big deal. Three cheers for not getting super stressed out every time something needs replacing or fixing.
Thank you for checking out how saving an emergency fund can help you to never live paycheck to paycheck again. If you have any questions or comments, let me know, below! We want you to succeed, and baby steps may be necessary before getting to where you want to be. The important part is to start now. Decide how much of an emergency fund you would like to have, where it will be kept, and set up automatic payments (even small ones) to make it happen. One day you will get to where you want to be, you just need to commit to improving. I know having an emergency fund will give you a stronger sense of security, more confidence, and help you design a better life.
That is so true that when it rains it pours! And as we have seen the past 2 years a financial crisis can happen at any time. Ad an emergency fund provides the buffer to keep you ready and give you peace of mind. Great tips!