Financial planners and advisors across Canada suggest you should save 3 to 6 months worth of expenses in an emergency fund. You’ve figured out how much you are aiming for, using some of the guidelines from my last video perhaps. But what does that really look like, and where should it go? That’s today’s topic.
Most agree on having 3 to 6 months worth of expenses (or income) available as an emergency fund. But where that cash should come from in an emergency varies widely.
This option won’t work if you’re tempted to dip into your emergency fund when you look at your chequing account and see that you have money available to spend. Also, holding the bulk of your emergency fund in a chequing account paying 0% interest is a lost opportunity cost.
This could be a separate account with your current bank, or a completely separate bank. Having both accounts at the same bank is more convenient and potentially easier to transfer money from your chequing account to your savings account. That can be a bad thing if you suffer from wanting to spend everything you see in your bank account.
Having money at a separate bank might be helpful to reduce this urge. Out of sight, out of mind. You can also move the emergency savings to a bank that offers a higher interest rate on your savings. Of course, if your total emergency fund is at another bank where it is harder to get at your money, you have to be sure you have the ability to pay for something immediately.
Some recommend using short-term GIC ladders or cashable GIC’s. A short-term GIC ladder might look like this. Let’s say you peg your emergency fund to be $8,000. You want to set aside $2,000 in a chequing or savings account so that it’s very liquid and you could cover additional expenses on a credit card or line of credit. That leaves $6,000 which you are mainly concerned about covering ongoing needs while you look for new employment if you were to lose your job.
You could ladder a number of short-term GIC’s so that they mature each month for the next 3 months. This month you would purchase a 3 month GIC worth $2,000, paying 1.6%. Next month, you’d invest the next $2,000, and the month after that you’d invest the final $2,000. When the 3 month GIC matures, you’ll roll that over into another 3 month GIC so you’ve got $2,000 maturing every month for the foreseeable future.
This means that you would hold onto the GIC for a year and earn an interest rate of 1.25%. However, if you needed the money before the end of the year, you could cash out as long as you’ve held it for at least 30 days. You’d get a lower interest rate cashing it out early, but you’d still get some interest back. There may be certain restrictions around these, so be sure you read the fine print and ask lots of questions. I personally don’t think interest rates on GIC’s are high enough to go down this route for my emergency fund. Online savings account rates are more competitive and your money is liquid.
While this might be helpful in some cases where the emergency is short-term in nature and you could pay the line of credit off relatively quickly afterwards, I’d caution using a line of credit as your main emergency fund. If you were to lose your job and not be able to find work for an extended period of time, you’re just mounting debt onto an already stressful situation. Rising interest rates would exacerbate problems and the bank may view you as less creditworthy if you’re not earning an income.
I personally take a 3 pronged approach. I have a buffer set aside in my chequing account, which ensures I have cash immediately available to pay ransom. I’ve seen too many Netflix dramas!. Having cash in my chequing account also enables me to avoid paying bank fees or going into overdraft. The bulk of my emergency fund is held in an online-only bank paying a pretty decent interest rate. Finally, I have a line of credit available if things really get out of control, and parent’s who would love it if I moved back home! In reality, most of my emergency purchases would be put on a credit card like my regular spending, but the emergency funds available in my bank accounts would allow me to pay off the balance before the due date. I don’t consider my credit limit to be any part of my emergency fund.
Have you had to use your emergency fund? I’d love to hear about your experiences or lessons in the comments below.
