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This is a topic that everyone knows about but usually little is confirmed. The standard personal finance rule of thumb is 3 months net income. The old method was to have the cash sitting in redeemable term deposits, a savings account, between the mattresses, etc. In the new age of ultra low interest rates, people are advised to have a line of credit available instead of having the money lay idle.
The Purpose of Emergency Funds
So let’s look at the purpose of your emergency fund. Normally, this is the cash you would have access to should you be in dire straits. Examples of true emergencies are: you just got laid off your job, became injured and are in the waiting period for your disability benefits or other less frequent issues such as being sued or having the roof ripped off your house by a natural disaster not covered by home insurance such as a tornado or hurricane.
Other Uses for Emergency Funds
Unfortunately, in my opinion, some folks have another measure for what consitutes an “emergency”. As a financial advisor, I have met clients who used emergency funds to buy a car, renovate their kitchen, thrown a party, gone on vacation… let’s just hope they don’t run into a real emergency before they rebuild their fund.
Who Needs an Emergency Fund?
The easy answer is everyone. The real answer is anyone for whom an emergency would consitute a financial risk. There are several questions to ask yourself to know if you need an emergency fund:
- What will happen if you lose your job?
- Where will your income come from if you are injured and can no longer work?
- How will you pay for urgent repairs such as a replacement roofs?
When you ask yourself these questions, you want to determine how to pay for important costs such as food, shelter (rent or mortgage payments), clothing; you know, the bare essentials.
In other words, you lose your job or worse, get injured and cannot work. How long will your chequing account last? Can you transfer funds from an existing line of credit?
How to Accumulate an Emergency Fund?
Perhaps, you always knew you needed an emergency and still don’t have enough cash set aside for that terrible day. What to do about it? Visit your favorite lending institution and ask them for a line of credit just in case. How many people actually do this? Not enough I dare say. As a financial advisor for the last six years, I looked for clients I could approve for loans that they did not need. Banks love to lend money to those who don’t really need it. If you wait until the emergency arrives, chances are better than average that the financial institutions will not touch you with a ten foot pole.
So, apply for a line of credit before you need it. While it is available, forget it is there (read: don’t use it), while you start a periodic savings plan with a high-yield savings account.
So, I’ll ask again: Emergency Funds – Where Are Yours? We would love to hear about situations you have lived through with (or without 8-( ) access to an emergency fund.
Author: Robert
