Building An Emergency Fund

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:

• Your car breaks down and you need to pay for repairs quickly
• A family health issue means that you need to fly across the country on short notice
• You lose your job, leaving you without income for a few months while you search for a new job
• Your home gets damaged by a flood, and you need to replace furniture and other belongings

 

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.

• Personally, I store my emergency fund in two accounts: a Tangerine savings account and an EQ Bank savings account. Both of those accounts are completely free to open / use, with no monthly fees or account minimums. There are unlimited deposits and withdrawals allowed.
• The reason for having two different accounts is that occasionally one of those banks will offer a promotional interest rate (for example, as of late 2023 / early 2024 Tangerine offered me a 6% interest rate for a period of 6 months). As such, I shift my emergency fund to the bank which is currently offering a more competitive interest rate.
• If you decide to go with Tangerine, you can input my “Orange Key” of 49163814S1 when you apply (absolutely no pressure). For EQ bank, feel free to use my referral link.If so, both of us will get a cash bonus deposited directly in our accounts (usually somewhere in the range of $20-$50 each). You need to open an account and deposit in at least $100 to receive the bonus.

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.