There have been a lot of news items (CBC news example) about massive layoffs resulting in bankruptcies, money crunches, and home foreclosures that I wonder if the financial planning concept of having an emergency fund is passé.

Lots of people don’t think they need one. They don’t really believe an emergency would happen to them.

The biggest reason not to have an emergency fund is because you can invest the money more lucratively somewhere else. The conventional rule of thumb of three to six months’ worth of income is a big chunk of money to have sitting in a low-interest account. You are actually losing ground each year because of inflation for a hypothetical emergency that could be years away – or may not happen at all.

Other arguments are that most people have credit available to them and high interest debt should be paid off first.

So do you just hope for the best?

Why you need an emergency fund

According to Vanguard, the top emergencies people face are: job loss, a medical or dental emergency, unexpected home repairs, car trouble, and unplanned travel expenses – emergencies are a fact of life.

All of us need some easily accessible cash to cover the unexpected.

There are two levels of emergencies. Your furnace dying in the middle of winter screams immediate emergency if you live in Canada. A job layoff could be long term lasting six months or more.

You could plan for some emergencies with targeted budget categories – home and car repairs, or major appliance purchases. Immediate needs could be paid from a line of credit or credit card, then tighten your belt until you can pay it off.

Related: Budgeting for irregular expenses

Keep some cash at home in case of a power outage and you can’t use your credit/debit card, or ATM.

Longer term emergencies need a greater amount of cash. Just how much you’ll need depends on a number of personal factors.

Longer-term emergency budget

Divide up your budget into Needs, Wants and Savings. Needs are expenses you can’t escape – your mortgage, utilities, groceries. Wants are things you can do without if necessary – dining out, gym membership, scrapbooking supplies. Put your savings plans on temporary hold.

An emergency fund should be based on your living expenses – not income. Once you know what it costs to run your life at the most basic level you can calculate exactly how much you actually need.

Assess the situation

One of the greatest emergencies is loss of income. Some jobs are more secure than others.

Do you have a high level of job security such as a unionized government employee or a tenured professor? Or are you the sole breadwinner working on commission?

How regular is your paycheque? What are the job prospects like in your current field? Do you have skills that are in high demand, readily transferrable skills, or solid connections? Would it take a while to find employment, maybe because you’re highly specialized or in a more senior position? Consider, also whether you may have to move to a new area to find comparable work.

Related: Budgets, cashflow, and spending. Yawn

It would be unfortunate to be forced to take the first job that comes along so you can pay your bills because you can’t quickly find other employment at the same level of pay.

In general, the less steady your paycheque and the more people who depend on your income, the larger it should be. Obviously the standard answer isn’t going to apply to every situation for every household.

If you are a two-income household, or have multiple sources of income, you may not need as much as if you were on your own.

If you lose your job you may be entitled to severance pay. Employment insurance provides some cash flow for a number of weeks.

Final thoughts

Do you really need an emergency fund?

You may not if:

  • You are adequately insured,
  • You have no debt,
  • You have more than one source of income,
  • You have a large (positive) gap between earnings and expenses,
  • You have access to a line of credit or investments that can be cashed.

Otherwise, look at an emergency reserve as insurance and not an investment. It is meant as a financial safety net.

Related: Build an opportunity fund

There are no easy answers. It very much depends on your situation. Different people have different levels of safety nets.

Ultimately you’ll have to do what’s best for you.


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