Canadians have more debt, on average, than any other country in the world. Even with the vast majority of debts coming from mortgages (70% of all debt in Canada is mortgage debt), Canadians still owe $630 billion in consumer debt: car loans, lines of credit, bank and corporate credit cards, etc. More than half of Canadians also have less than $10,000 set aside in case of an emergency.
With all this debt, Canadians have to seriously consider what will happen in an emergency. If you’re already heavily indebted, you will be in trouble if an unexpected expense or loss of income occurs and you have no savings but mounds of debt.
A recent poll from MPN Ltd. suggests that 46% of Canadians are within $200 of insolvency. It’s hard to say whether this number is completely accurate, as people may not be willing to open up about their finances or may even be overestimating how close they are to bankruptcy.
Even if it’s not completely accurate, that number should be alarming for everyone. $200 is not a lot of money when it comes to emergencies, but it is a lot of money when it comes to income. Assuming a tax rate of 20%, it can take 2.2 days to earn $200 after-tax, and a single flat tire can completely erase that level of savings. That’s money that you now can’t spend on rent, food, or utilities.
This means that people often avoid necessary but expensive tasks, such as going to the dentist, because they simply can’t afford it. Other people need to take on more debt to pay for emergencies that can’t be put off, such as replacing the engine in their only vehicle they need to get to work.
With so many Canadians living on the brink of financial disaster, it’s more important than ever to make sure you have an emergency fund.
An emergency fund is money set aside for emergencies. This isn’t your average goal-oriented savings account, like a vacation fund. Your emergency fund is your last line of defense against financial hardship in case the unexpected or unthinkable happens.
The most important aspect of an emergency fund is that it is highly liquid. Because emergencies can crop up at any time, having to wait to withdraw funds, or needing to pay to have them withdrawn, can increase stress or even force you to take on debt, depending on the nature of the emergency.
Investments could also be considered an emergency fund if it’s easy to sell them and withdraw the cash quickly. Savings accounts work best for this because you don’t need to sell cash and you can withdraw thousands of dollars immediately with electronic transfers. Certain investments are easier to sell than others (stocks are easier to sell than real estate, which is easier to sell than rare artwork), and some brokerages allow you to withdraw cash faster than others.
Murphy’s Law says that anything that can go wrong, will. There’s a good chance that you’ll run into a financial emergency at least once a year, if not more.
The worst part about emergencies is that you can’t plan for them. You can’t say, “Oh, and in May my car will need a new transmission.” Instead, you’ll just be driving one day and suddenly your transmission falls out.
That’s why it’s necessary to plan for emergencies in advance, and why it’s important to have enough money to cover something very expensive. We’re lucky in Canada that you probably won’t be bankrupted by getting sick, but breaking your leg and requiring crutches can still set you back $100 that you hadn’t budgeted for. You may also need to take unpaid time off work if your employer doesn’t have work you can do while sitting or from home.
Many personal finance experts agree on having an emergency fund that equals at least three months’ worth of expenses. This figure gives you time in case you lose your job, as you can keep paying your obligations without taking on more debt while you look for another job. Some financial planners say to have up to six months’ worth of expenses, to be extra secure. I personally believe six months is a tad too long. In Canada, the average duration of unemployment in 2017 was 19.6 weeks, or almost 5 months, so that would be a good benchmark. You don’t want to put too much into a simple savings account, because over time your money loses value to inflation. Once you have enough to cover 3 – 5 months’ expenses, you should start investing in long-term assets, or contributing to your TFSA and RRSP.
The best place for your emergency fund is a high-interest savings account. A HISA allows you to easily access your money at any time and lets you earn some interest on it as well.
The current best savings account interest rate in Canada is Hubert Financial’s Happy Savings account with 2.35%. You can’t make bill payments, direct deposits, or Interac e-Transfers from it so it isn’t suitable for everyday use. But if you’re just looking for a great place to park your savings, this is it!
Hubert Financial is a Manitoba-based credit union, not a bank, which means that it’s insured by the Deposit Guarantee Corporation of Manitoba (DGCM) instead of the Canadian Deposit Insurance Corporation (CDIC). Don’t let that scare you, though – the DGCM actually has better protection for savers than CDIC!
The CDIC only insures deposits up to $100,000 at member institutions. If you have more than $100,000 in savings, you can extend your coverage by splitting your deposits across multiple banks (each bank is insured individually).
The DGCM has an unlimited guarantee of all deposits in Manitoba credit unions. You don’t have to spread your deposits around to maximize coverage – it will be 100% covered at Hubert Financial.
Which account is best for you depends on what you need it for and how you plan to use it. Because everyone's needs are different, there is no such thing as the "one" best savings account. However, there are a lot of very good ones.
If you want fast access to your money and great features like making bill payments and unlimited free Interac e-Transfers®, the EQ Bank Savings Plus Account is a great place to put your emergency cash. If you think you might need to make withdrawals often or quickly, this is a great alternative to a traditional savings account.
EQ Bank’s online offerings are amazing, but one thing it lacks is the ability to withdraw cash. It’s a great replacement for your bill payments, but you’ll have to hold on to a chequing account if you ever want to have cash on hand.
*Interest is calculated daily on the total closing balance and paid monthly. Rates are per annum and subject to change without notice
Something that is popular among homeowners with steady jobs is to use a home equity line of credit as their emergency fund instead of having it all in cash.
If your job is stable then this can be a great idea. Lines of credit only charge you interest on the portion you use: if you leave it open as an emergency fund, you aren’t using it most of the time. Instead of having several thousands of dollars tied up in a savings account earning 2.35% interest at best, you can put it into your preferred investments.
When you have to dip into your line of credit, the low interest rate allows you to spread the cost out over a couple months to help absorb the shock to your budget. Making the minimum payment is never recommended, but the cost of interest on a home equity line of credit over a few months is very low – perfect if you pay it off quickly.
Not every expensive situation is an emergency. Having money available can increase the temptation to spend it, but stay strong. When I said that an emergency fund is your last line of defense, I meant it. There are other options to consider before dipping into your rainy-day money.
Sometimes unexpected events aren’t urgent. If you already have your emergency fund built up, then you should still be saving money from every paycheque. That’s where you should be drawing from first, if time allows. If repairs or purchases can be postponed by a couple weeks or months, you shouldn’t be using your emergency fund.
A sale does not constitute an emergency. Neither does a vacation, or wedding, or missing a couple days of work because of the flu. The temptation to spend increases along with the value of your account, but having a strong sense of why you have this money set aside will help stop you from spending it frivolously.
You should only be accessing your emergency fund when your only other option would be to borrow money. It may sting to take money out of your budget that you had planned to use on a trip, but unfortunately life isn’t always accommodating.
For this point, I consider withdrawing money from your RRSP to be “borrowing money,” as not only do you have to pay high fees and taxes on withdrawals, but you’re taking away money from your future self. Use your emergency fund before resorting to your RRSP.