[This article also posted to Linkedin here]
Last week I posted a comment on social media linking back to an FP Canada survey that noted, among other interesting observations, that “almost four in 10 (37%) Canadians say they rarely or never put money aside in an emergency account.”
In my cover comment, I mentioned that I myself had three types of such funds or reserves – emergency, bridge and buffers – and that they served me well recently when I was going through career transition. (For those not familiar with the latest lingo, that means I was between employers.)
Someone asked me what I meant, and how I quantify those. I gave a short response (it being fleeting social media), but thought I’d provide here a bit more detailed explanation of how I view and use these three types of reserves.
What’s your emergency?
The problem with a blanket emergency fund is that most people don’t define what constitutes an emergency.
The classic ‘I’ll know it when I see it’ view is no help. That could make it anything from just a slush fund – as in literally, ‘I could really go me a slush on this hot day’ – all the way up to it never being touched because it would require worldwide armageddon.
In my 3-part distinction, an emergency is something that is truly unexpected due to its nature and/or timing, that demands an immediate and significant financial response. It’s a medical diagnosis no-one expects, or property damage beyond what you reasonably insured for, or maybe even a new addition to the family well after you’ve auctioned all the stuffies on Kijiji.
So, mea culpa, I’m not giving it a specific definition myself. I am however setting aside an amount every week (which was reduced but not paused during career transition) so that we’re prepared for that non-ventuality. If that emergency doesn’t come as we’re nearing our work-optional threshold, it may accelerate that date a bit, keeping in mind (and keeping in reserve) that emergencies can happen at any life stage.
A bridge to … when
I started with the emergency fund above, in keeping with what people expect to discuss as the primary reserve. I too have written using this umbrella reference. Getting more nit-picky on how I parse it out personally, what many people call an emergency fund, I call a bridge fund. So despite that I’m writing on it second, I believe this to be the first priority topic and target among the three.
It’s a bridge fund because it allows you to keep moving forward in your life journey when the road beneath you has been washed away.
With all due respect to thumbnail wisdom, an arbitrary target like 3 or 6 months has nothing to do with specific circumstances, though I wouldn’t argue against this as impetus to begin funding one’s reserve.
Ideally your bridge fund is based on how much time it takes to get re-situated or re-employed, based on a clear understanding of yourself, your skills and the state of your industry. That’s on the income side, or more aptly the absence of income.
Express that in terms of weeks and multiply it by your ‘lean budget’ (deferring discretionaries and luxuries), and there you have your accumulation target. Now determine how much you can devote to that from your current weekly budget and that tells you how long it will take to get your bridge fully funded.
Buffering up the budget
The last component – buffering – is a practical application of the budget categories we use to keep our financial lives in order. I’ll assume here that you are not just using a single current/chequing account for all purposes.
For me, there are about 10 major categories, with 50 or so individual line items. Of these, a couple dozen warrant their own distinct sub-account at your favourite financial institution. Though I’m paid bi-weekly, there is an auto-transfer from my main account to each of these sub-accounts, regardless whether I expect to spend anything that particular week. For example, my electric bill is paid monthly, but the account gets a weekly drip.
Now here is where the buffering comes in. My spreadsheet sums actual past monthly amounts in each category to arrive at an average monthly cost. (I update about quarterly.) This then is divided by 4 for the weekly drip. The benign deception (to myself) is that though I’ve effectively divided by 48, the drip occurs in every one of the actual 52 weeks. Thus each account is modestly indexed by about 2% over the year.
It’s a small and almost unnoticeable cost for me to pay (myself) over the year. In truth, I started doing this as a way to slowly index for year-to-year inflation, rather than having an unpleasant surprise that shocks the budget and knocks my resolve every January.
And yes, I do skim out some from the accounts occasionally, but I haven’t been compelled to top-up any of them in any serious way. In fact for the larger ones, like the appliance account, it’s a couple months ahead of need, despite having to use it for its intended purpose twice this last year.
That’s it, three ways that I use reserves to create comfort space in my finances.