You'll inevitably encounter a few rainy days in your life. Make sure you're ready for them with an emergency 'rainy day' fund.
Throughout our lives, we’ll have some beautiful days, full of sun shine and balmy breezes. But, we’ll also experience a few stormy days along the way. On those days, you’ll be you have that umbrella handy. That’s the general idea behind an emergency fund. In life, those metaphorical rainy days usually don’t show up in a forecast—they arrive out of the blue—so it’s best to be prepared.
You never know when disaster will strike. Maybe it’ll take the form of an unexpected job loss or illness. Your truck could break down when you need it most. Or, a tree could blow over in a storm, damaging your roof. You can’t predict when these potential problems will occur. But you can prepare for them by setting up an emergency fund.
An emergency fund is money that you set aside for life’s financial emergencies.—it makes these unpleasant surprises more manageable by reducing your dependence on high-interest debt options, like credit cards and unsecured loans.
So, you’re ready to start an emergency fund? The first step is to determine how much you’ll need to save. Most financial experts recommend having enough cash to cover at least three to six months’ worth of household expenses. To figure out that amount, just add up all your expenses for one month, including your mortgage, bills, gas, groceries and so on. Then, multiply that number by three to get the minimum amount, and by six to get the maximum amount.
Another common recommendation (that’s easier to work out) is 25% to 50% of your yearly income. For example, if you have an income of $80,000, you might want to try and save between $20,000 and $40,000. Although salaries and monthly expenses vary, it’s bound to be a big number. But with the right planning and discipline, it could be manageable.
When saving for your emergency fund, your best bet is to make a plan and stick to it. Figure out your target amount, let’s say $20,000. Then decide on a reasonable time frame, maybe 3 years. Divide your target amount by the number of months and you’ll get your monthly target. So, $20,000 divided by 36 months would mean you should try to save $500 - $600 each month for three years.
Now that you’ve started saving, you have to consider where to keep your money. Your emergency fund should always be highly liquid, which means you should be able to access your funds at all times. You never know when a financial emergency will hit, so you should ensure your money is there when you need it. You should also try to avoid any risky investments, like stocks, where there’s a potential for you to lose your emergency fund.
We recommend opening a separate high-interest savings account , so you aren’t tempted to dip into it. A short-term GIC is another great option, where you can cash out early without risking your principle investment. One thing’s for sure—once that rainy day arrives, you’ll be happy you have your umbrella handy.