Programming, Investing and FI

Emergency Fund Please!

That’s a given, an emergency fund is needed, always. In my honest opinion, it should be proportional to the amount of risk you’re worth but different points of view exist on the matter. Some say that you should keep 2 months, 3 months, 6 months, a year… But in the end it depends on you and the risk you’re carrying.

Emergency Fund - Fonds d'urgence

So what’s an emergency fund?

Easy! An emergency fund is some cash that you will put in a money market fund or simply a savings account for quick access. In case something goes wrong with your day to day life, it will be there to keep you from drowning. For example, you hit a deer and need to spare some money to pay the deductible, pretty hard to predict isn’t it. Maybe you need to replace something in your house immediately, a water tank or the roof. This can represent a large sum of money and you don’t want to have to withdraw money from your RRSP or your TFSA! Especially if you’re aiming for FI (financial independence).

That’s an emergency fund: some money that will not be invested in case of rainy days. It will most probably sit in a savings account.

How Much in the Emergency Fund?

Well that’s the big question everyone is asking. It depends on how much you spend per month, that’s the first thing because if things go south, you want to be able to cover some basic expenses for a set duration. Let’s say for grocery, car, house (or rent) I need about 2 500 $ per month. Then I will have to adjust depending on my tolerance to risk and the extra I want to provide. I think it’s logical to say that the more stuff you own, the more that can go wrong. That means you will need a bigger emergency fund to help you sleep at night.

If I take the amount above and multiply it by 6 months, that will give me basic expenses for half a year. That is, 15 000 $. That’s a lot of money! I would need to add some on top of it to cover the expense of whatever will go wrong, let’s say 2 000 $. For 6 months of ensured living expenses, I would need 17 000 $ in cash. That’s a lot indeed, maybe an idea would be to spend less or use only one car… or simply play with fire a bit more and stick to 3 months of living expenses. Maybe something in between then like 4-5 months. The time you need to save for will be evaluated by your own risk assessment.

Creating an emergency fund depends on its owner more than people can think in my opinion. It’s a constant battle between the most you can save and the less you have to keep in a savings account. Let’s face it, a savings account only reduces a little the impact of inflation on your money. You don’t want to keep money there if you don’t have to, you want it working for you after all.

How to Make the Most of It?

Well, there is no magic involved, if you want to invest more and reduce the amount of cash sitting, you have to lower your risk and/or monthly expenses. In the previous case, if I manage to reduce the number to 2 000 $ instead of 2 500 $, I would need 14 000 $ instead of 17 000 $ to cover 6 months of expenses including 2 000 $ extra cash. reduce it more and you will have even more play. The number of months involved depends on your tolerance and weather you have a stable job or kids or whatever else.

Lowering your risk can also mean that you will stick with only one car, a smaller house or less toys that can break.

My Strategy

I will try to give you and idea of how I proceed to hopefully help you with a real life example. First, I don’t have much on my shoulders and I try to keep it that way, I only own one car, my apartment and my small business. All of the stuff I own does not require much repair or if it breaks, it won’t be the end of the world for sure. My car is fairly new and is still on warranty but ensures a big monthly payment that I must be able to make. The apartment also has a monthly fee but I know it’s always going to be quite similar from one month to the other. This reduces the risk as I know exactly how much it’s going to cost me from one month to the other.

I can also tolerate a fair amount of risk because have some bonds in case something really goes wrong and I need to take money out of my standard investment account. Oh yes, I have money in a standard investment account which reduces the risk to have to withdraw from a RRSP or a TFSA. All in all, I am not really risky except for my employment security which I don’t really have. Still, I have multiple sources of income to reduce that risk. That’s why I choose to stick with 3 months worth of expenses instead of 6. It’s a personal decision from my risk assessment and my own tolerance.

Finally, the demand in my field is pretty strong right now and finding a job is fairly easy if you have a decent amount of experience. The point I am trying to bring to the table by evaluating my current situation is that there are multiple ways to do things. Still, you must regain control of your finances and know what goes where before you can really assess your risk. Then, depending on your personality and how you feel about your situation, you might decide to keep a larger or a smaller emergency fund.

Tips on How to Grow an Emergency Fund

I admit that creating an emergency fund is far from the most interesting task. Especially because it does not bring back much interest compared to other investments. At the moment if you keep it in a high interest account you might get something like 1 % if you’re lucky. Gone are the days when it would bring back like 3.5 %.

You might want to try to cut one thing that does not bring you much happiness in exchange of creating an emergency fund. Cut your daily Starbucks coffee and you can save about 840 $ a year! That’s only with the coffee. Quit smoking and you’ll save a lot more. If it’s too hard to completely cut coffee for example you might want to replace it with something less expensive like tea that you buy at the grocery store. Also, stop buying bottled water right now and drink water from the tap instead. It’s a little ironic that people don’t want to drink tap water while they drink soft drinks which are wayyyy worse for their health…

Another good idea is to find a fixed amount to be transferred to your savings account monthly (or each paycheck). That way you won’t even see it go by. Just make sure to define a feasible amount or else you will always be too tight at the month’s end, not fun. Make it like a budget optimization challenge!

The Difficult Part

Once you find the things that you want to cut, watch the money pilling up month after month and stop when you’re done with your objective. That brings us to the most difficult part which is keeping it there and not touch it. I suggest putting the money where it’s a bit more complicated to reach, like in a money market fund or the like. That way you will have to sell shares or transfer funds in your account. It’s going to take a day or two and will discourage any attempt to just grab a 20 $ here and there.

Why Would I Absolutely Need an Emergency Fund?

Here are a few more good reasons:

  • Lowers your stress! It’s proven that money is one of the biggest stress factor and honestly I don’t even have to put a quote on that;
  • Gives you leverage on your next pay raise negotiation, you will be less tempted to let go because you know you have enough time to find another job if things don’t work out;
  • Protects your investments from the urge to take them out if things start to go bad. Therefore miss out on some juicy gains;
  • You never know when something might come up like your car breaking or the like.

Take this other scenario: the stock market crashes and you lose your job. You didn’t have an emergency fund and you now need to go back to your savings and grab some money. Let’s say the stock market went down by 50 % and you had 100 % stocks. Chances are that the stock market will grow eventually to 200 % your initial value in 10 years. That is, when you take money out when it’s at 50 % its initial value, you are really lowering your potential long term gain. If you prefer tangible numbers :

100 000 $ before crash, then 50 000 % after crash. Each dollar you take out is actually worth 4 $ given that, in a few years, the amount will be worth 200 000 $. Just another good reason why to keep an emergency fund, you never want to dip in your investments during a stock market crash!

As you can see, the main goal stays to keep your investments safe while you live your life along with the ups and downs that occurs naturally.

Happy investing and be sure you keep that emergency fund at hand! We never know what’s around the corner!

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