How to set up an emergency fund
One of the building blocks of sound personal financial management is the emergency fund.
People who live paycheque to paycheque without financial reserves of any kind will be the first to tell you the fear of an unexpected expense can cause sleepless nights. Those who have taken the steps to set up an emergency fund will tell you how liberating it can feel: Like a weight being lifted off your shoulders. And those who've established a well-funded short- and long-term emergency fund will have an easier time continuing to strengthen their overall personal finances.
So the emergency fund is a great building block to start with if you don't know where to start when it comes to managing your money.
Easy access, low risk
The whole idea of an emergency fund is that you have access to money in short order. There are two parts to that: it has to be easily accessible, and it shouldn't be tied up in risky investments. For easy access, a high-interest savings account is ideal and simple. It's also about as low as you can get on the risk scale, so it checks off both boxes. If you have unused Tax-Free Savings Account contribution room, you can go one step better by setting up a high-interest savings account inside your TFSA.
The reason you don't want your emergency fund to be in riskier investments is that over the short term, those investments might be worth much more or much less than what you put in them in the first place. Since we can't predict the short term movements of investments with any certainty, and we can't predict when emergencies occur, we don't want to run the risk of not having enough money in an emergency if the need arises.
Finding the money for an emergency fund
After you open your new account for your emergency fund, you then have to start putting money into it. If you feel like you're just making ends meet it can seem like a daunting task, so here are some tips to help get you started:
- The easiest thing you can do is set up an automated transfer into your new emergency fund. Even $5 per week is better than nothing, but set aside more if you can manage it.
- Set a goal. Start with a smaller goal that you can achieve in three months. For example, setting an initial target of $500 would require an automated transfer of $40 per week. After 12 weeks, your account would be at $480. Tracking your progress can reinforce your efforts.
- Don't stop. Once you've hit your short-term goal, keep it up. $480 isn't going to last long if you have an emergency large enough to interrupt your income.
- Transfer in lump sums. If you get a bonus at work, or cash gifts from family and friends, consider putting a chunk in your emergency fund.
- Have a virtual garage sale to bulk up your account. Everyone, and I mean everyone, has junk in their homes. But one person's junk is sometimes another person's treasure. Anything that is basically taking up space is fair game for online auction sites or classifieds. Take the proceeds and dump them in your account.
- Try a temporary shopping ban. Blonde on a Budget blogger Cait Flanders is in the middle of a two-year shopping ban, but that won't work for everyone. Cutting out the wants in life for a month or two is a great way to kick-start any savings plan if you have the motivation. (Just remember to avoid celebrating by rewarding yourself with an expensive treat!)
- Haven't created a budget yet? Now's a great time to start. Take an inventory of what you've been spending, and then do a line-by-line analysis to see where you can cut the fat. Any savings you find should be converted into additional automatic transfers to your emergency fund. Here's a video to show you how to do that step-by-step.
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