We have been told time and again that every household should have an emergency fund and it’s true. But what kind of unexpected expenses should you plan for and how much is enough?
First, we need to differentiate between unexpected expenses and occasional expenses. An occasional expense, such as an oil change, is something that you plan for. An example of an unexpected expense would be needing a new front bumper because some surprise freezing rain passed through Ottawa, so you slid off the road on your morning commute.
COMMON REASONS FOR AN EMERGENCY FUND
- Surprise income shortage due to job loss
- Unexpected medical expenses
- Car repairs
- Large, unforeseen purchases such as a furnace or fridge
When we’re faced with surprise expenses such as the above, bills are usually paid by credit card, a line of credit, or payday loans. The average interest rate Canadians pay on a credit card is 19.9%. As high as that is, it’s better than 442% – which is the average interest rate for payday loans in Canada. Such high interest rates create a cycle of debt which is very hard to break.
A line of credit seems like the better option; a secured line of credit has lower interest rates, however it’s usually tied to an asset – your home, for example.
HOW MUCH SHOULD YOU SAVE
The general rule of thumb used to be saving three to six months of living expenses. That doesn’t apply these days, because Canadians are struggling with debt. An average of $73,000 per household. With such extreme debt, it makes more sense to put your savings towards that.
So what can you do? The higher the debt you hold, the smaller your savings should be. When the debt is at a much more manageable rate, you can then start to save; and as you’ll read in the tips below, you’re going to start slow.
TIPS FOR STARTING YOUR EMERGENCY FUND
Despite our amount of debt, the Government of Canada shows us that about 65% of households in Ottawa do have an emergency fund that can cover three months’ expenses. That’s great to hear, but show’s there is still a lot of help needed. Try these popular methods for increasing your savings…
- Open a savings account: You want to have easy access to your money, but you also don’t want to lose out on earning interest. Make the account separate from your daily transactional account. Look for no or low transaction fees as you may be making deposits on a regular basis. You also want to make sure there are no limits on how much you can withdraw at a time.
- Start with a realistic amount: Don’t panic if it takes months or years even to reach your goal. A small amount helps ensure you don’t get discouraged; $10 a week adds up to $520 after a year.
- Automate your contributions: Most online banking platforms offer weekly or monthly transfers. You can even set it up so the contributions come out on the same day your pay cheque is deposited.
- Swap expenses for savings: Some find it helpful to stop buying coffee or lunch out and put those funds into a savings account instead.
As you can see, having an emergency fund is an important consideration but you have to remember to pay yourself and your creditors first. If the interest you’re paying on a loan is higher than interest you’re earning on your savings account, then you’re not ready to start an emergency fund, that’s ok – you’ll get there, as we mentioned above, it’s just one step at a time.