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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9 Comments

  1. Cool Koshur on March 8, 2016 at 9:15 pm

    I tend to agree that emergency fund should be equivalent to at least 6x your monthly expenses even if you have two incomes. If you are more than 50+ then I would like to see even bigger emergency fund. Worst emergencies are loss of spouse particular if he/she is sole bread earner, followed by job loss. That is where life insurance is critical. Typical household is barely making enough to pay the bills and having 6 months emergency fund is out of reach for most Canadians. People are even tapping into retirement accounts to pay down debt. Apart from emergency fund, I would suggest applying for personal line of credit as a last resort for emergency fund while you are employed. This is your lifeline in case something drastic happens.

  2. Gary @ Super Saving Tips on March 8, 2016 at 11:20 pm

    One type of emergency that I don’t see talked about often is job/income loss due to disability. It’s important to have long-term disability/income protection insurance, but that doesn’t replace your entire income. Typically just as your income is being reduced, your medical expenses are increasing, and this is exactly the type of situation that may require a significant emergency fund. Too many people believe such a disability can’t happen to them, but perfectly healthy people can still suffer a sudden illness or injury.

  3. Judy on March 9, 2016 at 6:39 am

    I like having an emergency fund. It gives me peace of mind. Case in point, I recently had two broken teeth that require crowns within a couple of weeks of each other. I have enough in my dental/medical budget category (I use YNAB) to cover one, but not both.

    I am single, so I have no-one to rely on but myself. I like to be prepared for the curve balls that life inevitably throws at us.

    Also, regarding EI. First of all, there is a two week waiting period, and that is assuming you even qualify, the cheques are slow to start rolling in, and let’s not forget that it doesn’t replace your whole income. I think it is about 65%.

    One last note about lines of credit. When my husband passed away the bank froze our line of credit. I still had to repay the entire amount, but I could not take any money out on it. I would’ve had to re-apply on my own.

  4. DA on March 9, 2016 at 8:27 am

    I agree with Judy. Recent job loss in the family is a curve ball on us. the two weeks waiting period is a must for first time EI applicants. It is only 55% of the previous income, not 65%.
    Apply for the line of credit when you have a job, even though you really don’t need it. You may not get it when you don’t have a job. I like to have around $5000 in the savings account all the time. Mortgage renewal was another problem we faced along with job loss. But it turned out to be fine because we opted to keep the offer from the current company. Luck for us, the rate is still lower than previous one.

  5. May on March 9, 2016 at 11:15 am

    I would agree with everything you said except for the “stable unionized government job” part. I had a “stable unionized government job” and was laid off in spring of 2003 just when the bottom fell out of the IT industry. I was unemployed for 18 months and because I had no emergency fund, ended up wiping out my RRSP. Eventually, I started my own business as an independent contractor and never looked back. *EVERYONE* needs an emergency fund!

  6. Paul N on March 9, 2016 at 11:53 am

    Can one be disqualified from receiving EI if they have a lot of savings in the bank (the emergency fund)? Somehow I can see a conversation going like : “I’m sorry sir you are not qualified you have have too many assets”. Even though you paid into it for your whole life…

    Can anyone confirm that?

    • KC on March 9, 2016 at 1:26 pm

      Nope, EI is based on income only.

  7. amber tree on March 9, 2016 at 2:28 pm

    For us, we have 2 kids, the emergency fund needs to give us the peace of mind to get through a long period of problems and curve balls.
    Yes, we do get lower than inflation returns on this part of our capital. And no, I do not mind. It makes me sleep at night.
    I can not look into the future, I can not predict how much we actually need in a worst case. Having less would make me and my wife uncomfortable.
    Once the kids have their own job and hose, we might take another view.

  8. Susan J on March 9, 2016 at 2:32 pm

    Having an emergency fund is an absolute necessity! No matter what. End of story. I have too many stories to relate where people from all walks of life need this. It makes more sense having a low paying savings account than tapping into credit. Period. Then my husband became permanently disabled. We have peace of mind due to the fact we thought of and put in place a plan. And we don’t borrow or help out our children like a vast majority of baby boomers!!

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