Why Build An Emergency Fund?

Without fail, every time I talk to someone about debt or money management, they will tell me people need to build an emergency fund.

I don't disagree, but we rarely talk about why – or about what, exactly, constitutes an emergency.

The numbers scare people off too: "You should save six-to-eight months worth of living expenses." It's a nice thought, sure, but that figure is daunting, and undoubtedly more than enough to cause most people to drop the idea altogether.

So why should people build an emergency fund? When is it really a good idea to tap into these reserves?

And finally, are those rules of thumb about how much to save still accurate and applicable today?

The experts do say that saving enough to cover your living expenses for several months is still a good idea. Putting it this way though, leaves out an important bit of context: You're NOT going to save this amount all at once.

"I have the same challenge with my clients," says Avraham Byers, founder of Breakthrough Personal Financial Trainers. "They get stalled before they even get started." Saving this amount is realistic, he adds, but it needs to be done properly. "You're not going to save it in six months, but over the years, it's ideal if you can build that up. You should have at the very minimum, three months worth of expenses saved."


Why Save?

I've read and heard it said that interest rates are so ridiculously low these days that there is virtually no financial incentive to accumulate a sum of cash and park it somewhere.

Sadly, there's some truth to this. (If you're looking for someplace to park your cash, but still get at least a little bit of a return, check out our comparison of Canadian high-interest savings account rates.) There's an emotional component to saving, though, that shouldn't be discounted. There is a certain peace of mind that can be had, knowing that emergencies – both those that can and probably should be anticipated, along with true, genuine emergencies – won't put you right in the hole or wipe you out financially.


What's An Emergency?

A real emergency is something which needs to be taken care of rate away.

An emergency is not the need for new clothes (job interview or no), or a great sale on flights to Florida. Byers says "discretionary expenditures like vacationing or renovations, things that don't need to happen, are by far the biggest stealers from the emergency fund" that he sees.

Even though it can come from your emergency fund, an unforeseen veterinarian bill is something that should probably be anticipated and budgeted for in different part of the family balance sheet as well. (My apologies, dear reader, but the experts say you should also have an "unexpected, expected expenses fund" for items that are unplanned, but which probably can be anticipated. Car repairs, the need for a new roof, furnace or other home maintenance, even the possibility that your child will need a tutor, can all fall into this category.)

"You have a car. It's a little old. It's going to need repairs. Your house is having plumbing problems or electrical problems," says Elena Jara, director of education at Credit Canada Debt Solutions. "They're expected expenses, yet they become unexpected, emergency expenses because you don't want to face it, and you don't put the money aside."

There is some grey area in all of this: Unexpected computer failure, for example, even if such things should be anticipated and saved for ahead of time, can be an emergency, particularly if income depends on it. If your income is not dependent, however, if there are other devices you can use to make-do, or if you're just looking for the next upgrade, a new computer is not a good place to spend your emergency funds.

Emergencies can be major – job loss, a major illness in yourself, in your spouse or dependent child – or they can be minor. My own income took a significant hit this summer after I allowed a new client to hijack almost a month of my time, without ultimately delivering the work we discussed. (Should I have anticipated this? Maybe, but it was a first for me.) At the same time, a close family member got sick. In two months we spent more money on road trip gas and parking than I would normally spend over the course of two years.

Here's the reality: Since we're talking money, there's a very good chance the emergency – something you truly would not normally anticipate – will likely involve a gap or a drop in your income. This is how a lot of people find themselves sliding into debt. The very nature of the word 'emergency' implies there will be other stressors involved as well.

"Anything that has to do with your children, your health, your car or something else you need for work, those are emergencies," says Jara. "Those are true emergencies, and they will need to be taken care of right away."



Related Links:
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Women Financially Vulnerable To Widowhood & Divorce
Hiring a Contractor


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Kate McCaffery is a freelance writer, editor and former urbanite, now living somewhere in between the lake, the ski hill and some farmer's cow path. Visit mccaffery.ca/kate2.0/ for more information.