An emergency fund can help you handle unexpected costs without having to take on debt. Even if you never use it, it’s nice to know there’s a money cushion there if you need one. Here’s how to build and maintain one that suits your life.
The lowdown
- An emergency is an unexpected expense that needs to be paid quickly
- Your ideal amount depends on your income, expenses and circumstances
- Start with a manageable target and build from there
- Keep emergency savings somewhere safe and easy to access
- Review your fund when life changes
We’ve all been there. The exhaust on the car you need for work suddenly sounds very unhappy and the diagnosis isn’t good, or cheap. Or the furnace decides to pack it in—just before winter. Or that seasonal job you budgeted for falls through at the last minute.
An emergency fund is simply money set aside for unpredictable events like these. This financial cushion helps you pay for unexpected expenses without using your credit card or line of credit, or taking out a loan.
Here’s how to build an emergency fund that works for your income and circumstances, now and down the road.
What counts as an emergency…
Your emergency fund should be left for expenses that are both unexpected and necessary. Often these bills might also have to be paid straight away. True emergencies include:
- An urgent car or home repair
- Another type of unexpected bill
- An emergency trip for family or other reasons
- A sudden reduction or loss of income
- A major event, like a pandemic, flood or wildfire
What each of these have in common is that you haven’t budgeted for them, and their impact causes an immediate problem that needs resolving—from not being able to get to work to needing to cover household expenses for a family with children.
Without an emergency fund, unexpected expenses that need to be paid straight away may have to go on a credit card or line of credit. However, doing that can impact your budget for quite a while, and make an emergency even more costly.
…and what doesn’t?
WitThen there are the non-emergencies that might seem important, but are they really? A last-minute vacation, for example, isn’t an emergency—no matter how much you need a break. Neither is a new phone when your current one still works fine. And, however strongly your five-year-old feels about wanting that walking, talking robot, sadly for them it doesn’t qualify as an emergency either.
Vacations, non-essential purchases, presents, holiday and birthday celebrations, etc. are all things that you can plan and save for, along with other predictable expenses that crop up during a typical year. That money is best put in dedicated savings accounts for short- and long-term saving goals.
How much do you need?
You may have heard you should aim to save three to six months of essential expenses. That’s a good rule of thumb for an emergency fund that cushions you against everything from an urgent household repair to a large loss of income or job loss.
However, you can also come up with your own number, tailored to your expenses, income and general financial situation.
Consider how much you need
Figure out how much you’d need to cover essential household expenses if you suddenly had no income. These expenses could include housing, childcare, groceries, utilities, transport, insurance, debt payments and any essential healthcare costs, like prescriptions. In an emergency situation, you would be cutting back on a lot, so focus on the things you have to keep paying.
Consider your circumstances
Everyone is different. Someone with a steady paycheque, some savings and no debt may be happy with a smaller cushion compared to someone who is self-employed or does contract or seasonal work. And a single renter will have different expenses from a family with children and a mortgage.
The three to six months of expenses is a good benchmark, but the important thing is to build an emergency fund around your life.
Start small and build from there
As with all saving, it’s a good idea to start with smaller goals and build up to your end goal over time. For example, a realistic first goal could be $500 to $1,000. That might cover a car repair or unexpected bill without resorting to using your credit card.
Remember, while a credit card might seem a good option in an emergency, the debt payments can impact your overall budget.
Keep going
When you reach that first goal, keep building. Target one month of essential expenses next, then three months and eventually six or whatever your end goal is. The important thing is to keep saving for your emergency fund ticking along in the background by making it regular and realistic—to the extent you don’t really notice the money coming out of your account.
Automate your savings
Automating your savings makes everything easier. Set up a regular transfer from your chequing account to your emergency savings account so the money moves before you have a chance to spend it. It’s an easy way to build savings over time without worrying about it.
What about when you reach your target?
Reaching your fund target is a cause for celebration, but instead of stopping saving, consider redirecting those realistic, regular contributions toward retirement, a home renovation, your next vacation or another longer-term goal.
Where should you keep your emergency fund?
Your emergency savings need to be kept somewhere safe and easy to get to, which usually means sacrificing the higher returns offered by investments. If you need money fast, you don’t want to find your fund has dropped in value or need to pay penalties to access it. However, you do want to find an option that pays some interest if possible to help you grow your fund.
A chequing account
This choice means your money is very easy to access, but you may receive little or no interest. It’s also a bad idea to keep your emergency fund in your everyday spending account, where it could easily be spent.
A savings account
This is the straightforward option. Accounts such as regular, investment and high-interest savings accounts offer different options and interest rates.
A Tax-Free Savings Account (TFSA)
A TFSA can also be a good place for emergency savings. It’s designed for both savings and investments. Choose a low-risk option that lets you access money set aside for an emergency when you need it.
Remember that taking money out of a TFSA doesn’t immediately restore your contribution room. The amount you withdraw is added back to your available room on January 1 of the next calendar year. Learn more about TFSAs.
Grow your emergency fund with your life
While an emergency fund is intended to sit quietly in the background until you need it, that doesn’t mean you should “set and forget it.” Your life can look very different five or 10 years from now. For example, a single renter today could be a homeowner with a family in 10 years time. Good times to review your fund include:
- Starting a new job
- A change in income
- Becoming self-employed
- Buying a home or taking on a new mortgage
- Starting or growing a family
- Taking on a new mortgage or other financial commitments
- Noticing your household expenses are increasing
- After dipping in to your fund
After reviewing any life changes, new expenses, and financial commitments, revisit your emergency fund amount or end goal. You can adjust your goal and savings plan as needed.
An annual financial checkup is a useful reminder to review your budget, savings and overall financial health regularly. If you have used your emergency fund, that means it’s done its job. After that particular emergency is over, focus on rebuilding the fund again.
How insurance fits into your emergency fund
Emergency savings and insurance work together to protect you in different ways. Insurance helps protect specific things against potentially large financial losses. These include home, tenant, auto, disability, life, travel and pet insurance.
While your emergency fund can help with associated costs if something happens that needs an insurance claim, such as deductibles, think of your emergency fund as an extra cushion within that overall insurance safety net.
For example, pet insurance can help with a large vet bill, while your emergency savings could cover the deductible or another expense not covered by your policy—as well as any other emergency that crops up.
As well as reviewing your emergency fund when your life changes, take a look at your insurance coverage as well to make sure you have the protection you need.
Waiting until you can save a large amount
Emergency fund mistakes to avoid:
- Waiting until you can save a large amountUsing it for non-emergencies
- Keeping it too close in a chequing account, or too far away in a hard-to-access place
- Not redirecting savings to other goals when you reach your emergency fund goal
- Forgetting to rebuild it after using it
- Not reviewing how much you need
Next steps: A practical plan to get started
Next steps: A practical plan to get started
Ready to build your emergency fund so you have a financial cushion when you need it? Here’s what to do next:
- Set a first target: Come up with a realistic first goal to get started
- Choose an account: Choose a safe, accessible account—separate from everyday spending and not exposed to higher investment risk
- Automate your savings: Set up regular contributions that are made before the money can be spent
If you’re not sure how much you should have in your emergency fund or where it fits into your broader financial plan, you can always talk to an advisor. They can help you look at your savings, protection and other financial goals together.