Pop quiz time. What is an emergency fund?
a) A fund that the government uses in times of natural disasters
b) A sum of money that hospitals use to pay for supplies
c) A fund that individuals have aside in case of unexpected circumstances
If you have selected the third answer, you are correct. An emergency fund or “a rainy day” fund is a source of money that individuals should budget for and contribute cash.
Here are answers to six common questions that individuals may have to decide if they need an emergency fund.
1. What do you mean by “unexpected circumstances”?
“Unexpected circumstances” from a personal finance point of view are situations that you did not budget for on a monthly or yearly basis. A common situation in which an emergency fund can be devoted to are times of unemployment. Whether you are eligible for employment insurance, you need to be prepared to make up for the shortfall of the money that you earn on a regular basis, especially if you wish to maintain your current life style. If you are not eligible for employment insurance, then you will need a source of money that you can use until you find your next job. “Unexpected circumstances” can also come in the form of repairs and maintenance to your car or home. In these cases, an emergency fund will prevent you from breaking your monthly budget.
2. When should I start contributing?
Contributing to an emergency fund should be done as soon as possible. Similar to a savings account or a tax free savings account, you should have your money work for you by earning interest over the long term. As a result, if you are working or an owner of car and or house, consider starting the fund when you have the money.
3. How much should I contributing?
The amount of money that you should contribute to your emergency fund will be dictated by your budget, specifically living expenses. According to financial planning experts, your fund should be able to cover between 3 to 8 months of basic living expenses. As a result, you may want to take a second look at your budget and see where you can find money to move into the fund. At this point, the amount could be small, however; the important things to remember are: 1) you are preparing for the future and 2) you are developing good money saving habits.
4. What if I have outstanding debts, should I still have an emergency fund?
You should still have an emergency fund despite your outstanding debts, however, you should pay off the debts that have a high interest rate attached to them, in particular wireless services bills and credit cards. For example, if you have planned to set aside $25 per month for the fund but you have charged $50 to your VISA card, it is advised to forgo the contribution and apply the $25 to pay the credit card bill.
5. Do I need a financial advisor to set up and manage my emergency fund?
To begin your emergency fund, you will need to speak to a financial advisor or a bank representative. Explain to the individual that you are interested in opening up an account for an emergency fund and be clear about your reasons. (Some representatives will attempt to sell you on another type of investment that maybe good for the bank, but not for you). When the account is open, you can decide how much money you would like to transfer and at what frequency. If you are comfortable with the internet, be sure to ask if you can have access to the account’s details on your client profile.
6. Should I keep my emergency fund separate from my saving and chequing accounts?
In a perfect world, you should keep your emergency fund separate from other accounts at a bank. Primarily, your emergency fund should be like a traditional piggy bank in which you can be deposits whenever you want, however; withdrawals should be done in times of emergencies. In addition, your money for the fund should be placed in a high interest saving account or tax free savings account. Your goal should be to have the fund grow over time thanks to contributions and interest earnings.
Building emergency fund is a challenging task to accomplish over time, however; when it is need, the source of money can helpful when unexpected situation occur that can affect your pocket book.
For more information on emergency funds, please watch the following video.