Yes, You Really Do Need An Emergency Fund

April 7, 2015

A woman in the dentist chairNearly 25 per cent of Canadians barely have enough set aside to take care of just one month’s worth of living expenses, according to a recent survey from BMO. And, that’s asking for trouble since it probably isn’t enough to comfortably handle root canal treatments, let alone a truly life-changing event like losing your job.

Whether you’re single, married or have a common law partner, setting up a contingency fund is a no brainer. The idea is to establish a source of money, readily and easily available, that helps you avoid tapping other financial resources at inappropriate times.

Why is it important to have an emergency fund? Studies have shown that people without emergency funds are more likely to fall into debt, simply because unexpected crises force them to take the first loan available, often driving them in to the hands of high-cost pay day lenders.

Emergency Fund vs. a Rainy Day Fund

Financial experts draw a distinction between an emergency fund and money set aside for a rainy day, and understanding the difference between the two can go a long way toward making sure that you aren’t setting yourself up for disaster.

Preparing for that rainy day

Your emergency fund should be reserved for more serious events that may last weeks or even months such as unemployment, disability, or major health issues.

A rainy day fund, on the other hand, is for something less catastrophic – like car repairs or replacing a broken washing machine – where you want to have a bit of money on hand to be able to settle your bills.

Most advisors recommend that, unlike retirement funds, this type of ‘what-if’ money should be kept fairly liquid, in a savings account or a money market fund.

How much should you set aside? Some say three months, six months, or even a year of your normal expenses. But there’s clearly no magic formula that works in all cases.

What you’re really trying to set up is the ability to live your life without having to worry about any particular crisis – and there’s no shortage of possibilities.

Planning for unemployment

What are the chances that you or your partner could be out of a job or perhaps earning less than you’re used to? How long could you manage on one income?

With the average length of unemployment lasting about 20 weeks (5 months), shooting for at least 6 months’ worth of expenses might be a good, if ambitious, target. And, the older you are the longer it typically takes to find employment. According to Employment and Social Development Canada, it takes on average 22.6 weeks to find employment if you’re between 25 and 54, 28.7 weeks if you’re between 55 and 64 years of age, and 32.2 weeks if you’re 65 and older.

Health and wellness

While provincial health programs will likely cover most basic ailments and their associated costs, you may have to look beyond that, particularly if you or your partner isn’t covered by a workplace health plan.

Make sure you have at least few months of expenses set aside for prescription drugs, dental and eye care, for instance, since these are generally not covered by government programs.

Broken relationships

Nobody expects their marriage to fail when they first start out, but it clearly happens.

A recent poll by Toronto legal firm Devry Smith Frank LLP found that while many unhappy Canadians hoped to split amicably, 53 per cent were worried about the financial impact of divorce, including the division of assets, unfair settlements or just how they were going to support themselves.

Having your own financial cushion in the event of a potential breakup could go a long way towards alleviating those concerns.

An emergency fund offers financial stability

Building up, and keeping, an emergency fund can help in the toughest of times. It allows you to focus on the ‘emergency’ and not how you’ll make ends meet. Bad things happen from time to time, but an emergency fund can help you get back on your way sooner.