Saving money is hard but when you do, it’s important to have a strategy. Paying down debt is critical and everyone talks about the stock market, but today we wanted to share a key piece of financial stability, the rainy day fund. Also known as an emergency fund, the concept is simple but often overlooked or executed incorrectly. Here’s what you need to know about your rainy day fund to get the most of it:
1) Make money on your money
You should, whenever possible, make money on your money. Banks give notoriously low interest rates on chequing and savings accounts. We recommend leaving just enough money in your chequing account to pay rent and monthly expenses and that’s it. Move any extra funds to something that will pay you some meaningful interest. Interest rates fluctuate and are different in each country, but you should usually be able to find something between 1-2% of guaranteed interest in Canada.
Why is this important? Let's take a look at two examples:
Example 1: One year at 0.05% (typical big bank)
Jenny keeps $5,000 in her emergency fund. In a typical big bank "Savings Account" she might make something like 0.05%
Example 2: One year at 2% (savvy saver)
Jenny did some research she finds a different bank that offers 2%. Over a year, this is how these two would perform:
Example 1: 0.05% yields [5000 * 0.0005 = $2.50] in interest
Example 2: 2% yields [5000 * 0.02 = $100] in interest
Jenny can pay her phone bill with $100 while $2.50 barely gets her a double double ☕️.
One product we’d recommend for holding your emergency fund is EQ Bank. They’ve consistently had 2%+ interest on their savings account for many years and currently have the highest non-promotional rate we can find. If you’re interested in joining, you can get a $20 welcome bonus with our referral link.
Another option that’s exciting is Wealthsimple Cash, but as of writing they haven’t launched all functions you’d like to see with an account like e-transfers and bill payments.
2) When should you use your savings?
Most people define a rainy day fund as something you’d only tap into for very unusual circumstances, like your roof leaking, losing a job, or for our American readers, a medical expense. In the end this is a personal decision, but you should think of an emergency fund as something that can help you weather not only these rare situations, but also even out some higher than normal spending, like around the holidays or a yearly vacation.
We still advise saving before any planned expenses to help, but if you have a small shortfall, choosing between using your savings or paying 20% credit card interest is a no-brainer.
3) How much should you save?
A good emergency fund is there to give you a cushion in hard times and is available quickly (that's why they call it an emergency fund). When you’re calculating how much to save, don't include any assets tied up in something you can’t spend within 1-2 days as an emergency fund. Mutual funds, stocks, gold, collectible stamps, none of these count.
Why? Because it's for emergencies and if you need to cash quickly you probably won't get the best rate. You might even open yourself up to taking a loss, so don't put yourself in that situation. Stability is the name of the game.
Most people recommend saving between 3-6 months of your usual expenses in your emergency fund.
Example: Balaji spends $1,200 per month on rent and $800 on other expenses (food, phone, etc.) and wants to have 4 months saved away. He should try to maintain [(1200 + 800) * 4 = $8,000] in his savings.
If you’re just starting out saving, even 3 months might seem like a lot, but just keep at it and you’ll get there. If you’ve been saving a while, you need to consider that 2% interest is not a lot in the grand scheme of things and is just enough to keep inflation at bay. As this is a personal choice, think about your risk tolerance to determine how much you’d like to keep liquid in your savings.
An emergency fund is a key piece of everyone’s financial planning:
- It is available quickly when you need it and can cover any unexpected expenses without causing you to pay high interest rates on a credit card or selling your long term investments
- A rainy day fund should provide you with material interest (~1-2%) so you can stay above inflation and not lose spending power over time
- Most people should aim to build up 3-6 months of expenses in their savings