Emergency funds are unnecessary
Many financial books and blogs recommend an emergency fund, sitting idle in a bank account, earning little or no interest. That money is supposed to sit there for the proverbial emergency.
I don’t know where this idea got started, but I find it useless.
Emergency funds are circumstantial. It depends on your income, your cash flow, your tolerance for risk.
How do we define an emergency?
Too often, People apply the term “emergency” to things that are completely predictable, forecastable, and plannable.
An emergency is an event that we are not able to predict.
If your car breaks down because you haven’t done any maintenance, that’s not an emergency, that’s lack of planning. On the other hand, if you have a car accident, and your car is destroyed and you have to spend a few days in the hospital, that’s something that you couldn’t have predicted and that’s an emergency.
How much money should you have in an emergency fund?
My opinion is that you should have $0 in an emergency fund. Emergency funds should not exist.
The case for low earners
If you are a low earner, chances are that you are living paycheck to paycheck. At this stage, the most important thing is to get out of debt. Eliminate the credit card debt takes priority, then the next high-interest rate debt takes priority, and so on a so forth.
Once you have paid all your high-interest rate debt, then start investing money in your TFSA. This money will probably grow at a rate of 8%. If you do have an emergency, then you have three choices:
- You borrow money from your credit card (only for 30 days) and then pay it back.
- You borrow money from your line of credit.
- You withdraw money from your TFSA.
Having credit card debt is the biggest emergency in anyone’s life.
The case for high earners
If you are a high earner, you have many options. At this level, you should not have any credit card debt. You probably have a taxable account, a TFSA, a line of credit, positive cash flow. You have many sources. There is no need to have idle money in a checking account when you have so many options.
The case for freelancers
For freelancers, it’s nice to have a buffer zone. Sometimes a freelancer gets lots of gig in one month and then there could be long periods of time without gigs. These are not emergencies, this is a cash flow money management problem.
I do wedding photography. I know that during the summer I get a lot of wedding gigs and cash is flowing in. During the winter I don’t get that many gigs and cash doesn’t come in as easily. However this fluctuation of cash flow is normal, it happens every year. As a freelancer, I have to plan for it.
Never do this, unless…
What not to do. Do NOT take money out of your RRSP. This money becomes taxable and you lose the contribution room forever. Unless, of course, you lose your job for a prolonged amount of time. In that case, your RRSP will be part of your income for that year.
Update July 14, 2020 (in the mids of Covid-19)
If there ever was a need for an emergency fund was during the coronavirus pandemic, when millions of people have lost their jobs and their lives.
I lost my two main sources of income. My dance school revenue and my photography business revenue. But over time, I have developed so many other sources of revenue, that I wasn’t hurting.
Over time I have created an emergency fund
I know that this is not the most efficient thing I can do with my money, but I have allowed an emergency fund to build in my checking account. After I have met my monthly savings objectives, whatever money I had leftover, I have let it sit there in the checking account, and now, I have labeled it “Emergency Fund Money.”
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