Building An Emergency Fund

Moonshine Money guide to personal finance - emergency fund header image

Bad luck always seems to strike at just the wrong times — life doesn’t have a habit of waiting for us. Having an emergency fund will help you get through these tough times, and to sleep more soundly at night.

In this lesson, we’ll learn about the ins and outs of what an emergency fund is, why you need it, where you should store it, and how much you money you should have saved up. You’ll also be tasked with starting one for yourself.

 

What Is An Emergency Fund?

An emergency fund is money that you’ve saved up for unexpected costs (and well, emergencies).

A few situations when an emergency fund would come in handy:

 

Why Do I Need An Emergency Fund?

If you don’t have money on hand to pay for these costs, you’ll need to borrow the money from somewhere else. For many people this would involve taking on credit card debt or a payday loan.

The interest rates on these products are extremely expensive (often 20% – 30%+ per year) and should always be avoided if possible. One small emergency could put you in a hole that takes years to crawl out of.

Having an emergency fund will allow you to get past these hiccups without putting a serious dent in your finances.

 

Where Should This Money Be Stored?

Your emergency fund should be stored in an account where your money is easily accessible — ideally within a couple of days. It should not be invested in any kind of risky investment, such as in the stock market.

You shouldn’t be trying to earn high returns on this money. These savings are your safety blanket; you should always know where it is, how much is there, and that you can easily get access to it.

Having a credit card or line of credit does NOT count as having an emergency fund. Your bank could take away your access to these at any time, and the money that you draw from these sources needs to be repaid with interest.

I recommend storing your emergency fund in a high-interest savings account (sometimes known as a high-yield savings accounts). These accounts will typically pay between 1% to 2% in interest per year, and the return is guaranteed (i.e., there is no risk of the account going down in value). This small return will help to offset the effects of inflation. Again, your goal shouldn’t be to earn high returns with your emergency fund.

You should make sure that any account you open allows you to withdraw the money quickly, and doesn’t require you to pay any monthly service fees.

 

How Much Should I Keep In My Emergency Fund?

There isn’t any hard and fast rule for how much you should keep in your emergency fund.

Most people should target to have an emergency fund big enough to cover 3 to 6 months of living expenses. For example, if you typically spend $2,000 per month, a reasonable emergency fund size would range from $6,000 to $12,000.

If you have others depending on your income, or if you don’t have much job stability, you could consider an emergency fund of up to 12 months of living expenses.

Before thinking at all about investing money, your first priority should be to get at least 1 month of living expenses saved up in your emergency fund.

 

Your Assignment

Step 1: Open up a high-interest savings account with your bank of choice. Make sure that this account allows you to access the money quickly and without paying any fees / penalties.

For Canadian readers: see here for a comparison of providers.

For US readers: see here for a comparison of providers

Step 2: Decide on the amount of money that you want to keep in your emergency fund. At a minimum, you should target to hold 3 months of living expenses.

Step 3: Start making regular contributions from your take-home pay into your savings account, until you reach your goal.

If you take money out of your emergency fund for any reason, remember to replenish it back to your target amount afterwards.

 

Moonshine Money: A Do-It-Yourself Guide to Personal Finance

Comment Section

6 Responses to “Building An Emergency Fund”

  1. David says:

    If you have CC debt and no emergency fund, I assume the first plan of action is paying that off entirely first?

  2. Jeff says:

    Wondering if you’re still making 2.5% at Tangerine. It currently says 0.1% as of March 2021

    • Hi Jeff,

      You’re right — rates are Tangerine are abysmal now.

      I’ve switched over to a high interest savings account at Alterna Bank — believe I am earning 1.2% currently.

      I think EQ Bank has the highest rate as it stands, but I’m based in Quebec and EQ doesn’t operate here.

      Will update this post accordingly!

  3. Mel says:

    Hi, I have a question. Should your emergency funds be different from your savings? Right now, I have just some money, it serves as both. But I take out of it as I need because I don’t have a stable job right now to meet my needs so I take out of it to pay my bills alongside the side jobs I could do. My question is if there was no limitation, what would you recommend? Maybe I should have a savings I can take out of so I don’t keep drawing out of my supposed emergency funds? (if situations were normal). I just want to have an idea of a plan? What do you think?

    • Hi Mel,

      Thanks for your question. Personally, I have two accounts — one account that I save/spend out of, and a separate account that I use to store my emergency fund.

      For the first account there are many ins and outs as I save and spend money. So that account balance fluctuates in value.

      For the second account, I treat it as my emergency fund, so I try not to touch that at all.

      Many banks (at least in Canada) allow you to open multiple savings accounts and rename them as you like. So, you could have one account called “Main” and one called “Emergency Fund”. That makes it easy to manage and track.

      An alternative plan would be to keep everything in one account, and stay disciplined that you never let the account drop down below the emergency fund level.

      Feel free to choose the plan that works best for your situation.

      I hope this helps!

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