Emergency Fund – Page 2

Whether clients are accessing funds or inspired to save for the next crisis, here’s what they need to know

In the sci-fi classic 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 clients last contemplated their emergency funds, a global pandemic would have been well at the perimeter of possibilities. And yet, here we are.

So, those with an emergency fund may now be asking: How do I use it? And those who don’t have one — but are fortunate enough to still be in regular earning mode — should be thinking about how and when they would use an emergency fund as they begin saving.

Regular budgeting addresses recurring expenses, plus reserves for periodic capital outlays. Insurance is for the extreme where there are remote-risk/high-peril events. An emergency fund lies between.

The fund allows a client to sustain their household in a time of crisis — whether that’s an unexpected injury, job loss or a global pandemic — while expenses continue to pile up.

How and when they should use the emergency fund is a function of how they define “emergency.” Encourage clients to commit to the above definition when they begin saving so it’s preserved for truly pressing needs — like now— and not depleted on emotional wants.

Using an emergency fund

Like Ender’s alien battle, we’re no longer practicing. It’s time for clients to actively monitor and log their spending. This will help them manage the current situation, and learn for future planning. This is how clients should use their emergency funds now:

The immediate non-negotiable needs are food and safety. Clients can cut down on these expenses by shopping brand-consciously, reducing cost-per-unit by buying in (reasonable) volume, and being vigilant about portioning and waste.
Shelter costs like rent/mortgage and utilities are next. Federal government income supports should help indirectly, and housing-specific relief may be on its way, whether from government, lenders, landlords or a combination. Whatever form and amount this takes, clients must understand why this is a top priority: interest and penalties on short/skipped payments will compound the emotional and money stress the very next month, and further impair a client’s finances in the recovery time to follow.
Dispensing with all discretionaries may not be practical as clients hunker down for the coming days and weeks, but they should be selective about the prudent pleasures they choose.
Suspend luxuries and harbour no regrets. Encourage clients to keep their focus on the present, comforted that their conscientious actions today will improve their prospects tomorrow.
Counsel clients to log where their money is coming from and where it’s going, so they can manage within their changing means. That’s a good habit in good times, and critical in a crisis. Many have a bit more time these days to form the habit.

Building a fund for future crises

The emergency fund’s purpose, now or after the Covid-19 crisis, is to have money accessible for a specific number of months. But how many? Clients should start by planning for the most likely emergency: an employment gap.

Based on the client’s industry and where they work, how long do they think it would take to get re-situated? An estimate provides a goal for the number of months of funding.

Second, while losing income is painful, what matters most in an emergency is spending. Help clients review their bank and credit statements from the last year, taking out anything truly extraordinary and deducting items they may be able to defer for a few months. Divide the total by 12 for a monthly average, and multiply by the chosen number of months. This is the client’s lower limit (the upper limit includes those deferred items).

Third, set up a regular deposit to the fund, ideally aligned with the pay cycle. Clients should assign a percentage or dollar amount they can commit to, even if it’s a small figure.

Now, the gut check: divide the emergency fund target by the weekly deposit commitment. This will show how long your client needs to get there. If they feel a knot forming in their abdomen, they may want to bump their commitment. But that unease must be balanced against the discomfort from the current budgetary sacrifice in order to arrive at a manageable medium.

As a kicker, an oft-suggested alternative to an emergency fund is a line of credit at the ready with a bank or credit union. For some people, taking on debt at a time of financial stress may be an uncomfortable proposition. Still, 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%, clients will have to take a higher gross amount to net to what they need. And if the withholding is less than the actual tax due, they’ll be scrambling to come up with cash at 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 re-contribution credit, which can be both the motivation and target for replenishment once the emergency passes.

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For a long time, we didn’t have an emergency fund, though we’ve had a line of credit (LOC) for quite a while.

Our household budget was within our means. We were operating fine in our regular spending routine without having to check when payday was coming. There was also a fair amount of reserve that had built up in the separate accounts we’d established for each of the major expenses.

It wasn’t for fear of holding money in no/low-interest cash that might otherwise be making investment income. No, that’s exactly the effect of those individual accounts anyway. Rather, we were confident in the arithmetic, and didn’t think there was a need to have that one account.

It wasn’t until we had to dip into one of those reserves to replace an appliance that our perspective shifted: Large though that reserve had become, it had a defined purpose and calculated amount that would eventually deplete it. Emergencies aren’t like that.

1. The why of an emergency fund

An emergency fund isn’t about being budget-conscious; it’s about potentially being UNconscious, indisposed and/or impecunious at a time when there remains a budget to be serviced. It’s about you and your ability to be the continuing funding source for your household.

It’s also about being able to respond to large, unexpected expenses. Be careful though not to confuse that with the major expense reserves mentioned above. Years will pass before those needs may arise, but while the exact timing may be unexpected, those remain inevitable.

At the other extreme from normal budgeting are unlikely things such as catastrophic property damage, permanent disability or death. Insurance is for those remote-risk/high-peril events. Between those two is where an emergency fund is situated.

2. LOC or emergency fund – What’s your gut feel?

Part of my own early confidence lay in the fact that as the mortgage was being knocked down, we’d set up a substantial line of credit. It was more than sufficient for the 3 months – or even 6 or 12 months – worth of accessible funds variously suggested to bridge until things would be expected to normalize after an emergency might hit.

But over time I became more familiar with my own emotional relationship with money. Ever since I had a mortgage … I didn’t want one anymore. Though we lived contently and made appropriate allocations to retirement and children’s education savings, the extra dollars were put toward trimming that large liability. That was the mindset and routine while in the midst of stable finance and balanced emotion.

So, how might I feel in a future time of monetary and mental stress, being compelled to dive deeper into debt? Not good in all likelihood. In fact, that prospect could easily exacerbate the impact of any emergency that may in fact arise, and extend out the recovery time. For us, that was when the formal emergency fund took shape, while maintaining the line of credit as the next line of defence.

That’s our family, not necessarily yours. Still, you would do your future-self a great favour by taking the time while things are rosy to contemplate how you will feel when things are not.

3. Deciding your __ months of money?

Assuming you’re committed to the purpose, the first action question to address is how much will you accumulate in that fund? The commonly suggested proxy is, as mentioned above, a certain number of months’ worth of accessible funds. But how many for you: 3, 6, 12, more?

As the timing and extent of an emergency is unknown, there is no formula to provide you with a definitive number. A practical approach is to focus on the most likely of those unlikely events: an employment gap, whether of your own choice or initiated by your employer. Knowing yourself and the industry where you work, how long do you think it would take to get re-situated? Other factors will come into play, like severance pay and employment insurance, but start here as a rough target.

Second, be clear about what this number of months means. In theory it is lost income, but more importantly in an emergency situation, it is the amount of spending that has to be replaced. The two are connected, but the latter continues even in the absence of the former.

Fortunately, unless you’ve been living excessively, your spending will be less than your earnings. Look back at your bank and credit statements over the last year. Take out the truly extraordinary things, and deduct items you can suspend or defer, at least in the short term. This is the monthly average to multiply by your chosen number of months to give you a target.

Third, how much will you regularly deposit into your emergency fund? By “regularly”, I mean weekly or in alignment with your pay cycle, which brings us back to your budgeting. As remote as an emergency may be, you need to assign a percentage or dollar amount that you can commit to, even if that’s a small figure.

Here then is another gut check: Divide your accumulation target by your weekly deposit commitment to tell you how long it will take to get there. If you’re feeling a knot forming in your abdomen, you may want to bump your commitment. Balance that against the discomfort of the current budgetary sacrifice to arrive at a manageable medium.

With a line of credit at your back along the way, you now have a process, timeline and dollar target to get your own emergency fund in place.

Tag: Emergency Fund

Emergency fund advice in a time of crisis