Getting yours going, and knowing when & how to use it

In the classic sci-fi novel Ender’s Game, gifted children play simulated battle games with aliens at the edge of the universe, until <<spoiler alert>> the title character realizes during an especially intense sequence that he’s in the midst of the real thing, and everything to that point has just been practice.

When you last contemplated your emergency fund, a global pandemic would have been well at the perimeter of possibilities. And yet, that’s what we all just experienced. How comfortable were you with how your finances fared in-the-moment, and how confident are you that you’re ready for a future crunch?

Positioning an emergency fund in relation to regular budgeting

If you had an emergency fund in place, you may still have found yourself asking: Is this the trigger, how much do I take, when and for what? And if you didn’t have one but were fortunate enough not to have been too displaced from your regular earning routine, you were probably jolted into thinking about finally getting one going.

Regular budgeting addresses recurring expenses, plus reserves for periodic capital outlays. Insurance is for the extreme where there are very rare but very costly events. An emergency fund lies between.

This fund allows you to sustain your household in a time of crisis – whether that’s an unexpected injury to you or a family member, job loss or a global pandemic – while expenses continue to pile up.

How and when to use an emergency fund depends on how you define “emergency.” Commit yourself to the above definition when you begin saving so that these carefully targeted savings are preserved for truly pressing needs, and not depleted on emotional wants.

Guidance for using your emergency fund

Like Ender’s alien battle, the pandemic pushed many of us out of practice mode and into active monitoring and logging of our spending. Whether or not that describes you, we can all learn from this painful episode, to help inform how we’ll use our emergency funds in future:

• • The immediate non-negotiable needs are food and safety. You can cut down on these expenses by shopping brand-consciously, reducing cost-per-unit by buying in (sensible) volume, and being extra vigilant about portioning and waste.
  • Shelter costs like rent/mortgage and utilities are next, as interest and penalties on short/skipped payments will quickly compound the emotional and money stress, further impairing your finances in the recovery time to follow. In the case of a widespread disaster (as it was with the pandemic), government support may be available, but if it is more localized or specific to your family alone, your financial resources will bear the primary or sole burden.
  • Dispensing with all discretionaries may not be practical as you hunker down for the days and weeks of any extended emergency period, but try to be selective about the prudent pleasures you choose.
  • Suspend luxuries and harbour no regrets. Keep your focus on the present, comforted that yesterday’s conscientious saving actions and today’s prudent spending choices will improve your prospects tomorrow.
  • Log where your money is coming from and where it’s going, so you can manage within your changing means. That’s a good habit in good times, and critical in a crisis. As was the case in the pandemic, you may have a bit more time on your hands (unwanted though it may be) to focus on budgeting, which could be a catalyst to reinforce your good money habits over the long term. 

Building a fund for future crises

An emergency fund’s purpose is to have money accessible for a specific number of months to carry you through the emergency. But how many? Start by planning for the most likely emergency: an employment gap.

1. 1. Based on your industry, geography and individual skills, how long do you think it would take to get re-situated? As you don’t know what the economic conditions will be, choose a figure between the best-case and worst-case scenarios to obtain a reasonable goal for the number of months your emergency fund may be needed.
   2. You may anticipate a payment from your employer on a termination. The amount will depend on the terms of your contract, including your income, seniority and the circumstances of your parting. While this should not be ignored, be cautious and conservative in your assumptions. If the situation is contentious, there may be a delay in reaching a resolution, as well as legal/professional fees you may have to spend before receiving the amount.
   3. While losing income is painful, what matters most in an emergency is spending.
      • Tally up your outlays as shown on your banking and credit card statements over the last year, taking out anything truly extraordinary and deducting recurring items you may be able to defer for a few months.
      • Divide the total above by 12 for a monthly average, and multiply by the chosen number of months you decided upon in step 1 – This is your lower dollar limit.
      • Add back the deferred items to estimate how long until those deferrals will be exhausted, again dividing by 12 and multiplying by your target months from step 1 – This is your upper dollar limit.
      • Choose a number between the lower and upper limits for your target emergency fund. Decide whether and how much this may be reduced by an anticipated terminal payment from step 2, again being prudently cautious in your approach.
   4. Next, decide how much you will make as a weekly deposit to the fund, ideally aligned with your pay cycle. Assign either a percentage or dollar amount you can commit to, even if it’s a small figure.
   5. Now, the gut check:
      • Divide your chosen target from step 3 by your weekly deposit commitment in step 4. This will show how many weeks it will take for you to accumulate your target emergency fund.
      • If you feel a knot forming in your abdomen, go back and see where you may be able to make some adjustments. Balance that unease against the discomfort from the current budgetary sacrifice in order to arrive at a manageable medium.

Supporting role for a line of credit

As a kicker, an oft-suggested alternative to an emergency fund is a line of credit at the ready with your bank or credit union. But for some people, taking on debt at a time of financial stress may be an uncomfortable proposition.

Even so, establishing a line of credit can be an effective complement to an emergency fund, knowing that it will be there to fill the gap if an emergency hits before the fund reaches its accumulation target.

Registered or non-registered?

Your RRSP is not an appropriate choice as an emergency fund. With withholding tax as much as 30%, you will have to take a higher gross amount to net to what you need. And if the withholding is less than the actual tax due, you’ll be scrambling to come up with cash at tax filing time next year. Withdrawing from an RRSP for an emergency also puts retirement at risk. Keep these two needs separated.

On the other hand, the TFSA is well suited for emergency needs. With no tax to deplete withdrawals, budgeting is much more transparent. Withdrawals are also entitled to the usual TFSA re-contribution credit, which can be both the motivation and target for replenishment once the emergency passes.