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5 questions about creating an emergency fund during the COVID-19 pandemic

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In the 2019 Canadian Financial Capability Survey, nearly two-thirds of Canadians said they had an emergency fund to cover three months’ worth of expenses.

Have you had access to the money you needed over the last few months?

Building an emergency fund makes sense in normal times, but not everyone is able to do so. Is it possible to create one during the pandemic? For some people, now might be one of the best times to get started.

If you or someone in your household is working more than usual right now, you’re likely at a higher risk of being exposed to the coronavirus. Setting aside the extra income you’re earning now in an emergency fund would be wise. Or maybe your income hasn’t been affected and your discretionary expenses have dropped significantly.

What should you consider and where should you start? The answers below should help.

1. How do I start building my emergency fund?

With the widespread shutdowns we’re experiencing, some families are saving more as they spend less on summer camps, sporting events, travel and dining. Some have even seen an increase in their income. Did you receive government support, like the extra Canada Child Benefit payment? Are you expecting a tax refund?

To start building an emergency fund, create and analyze your monthly budget to see how much you can afford to put aside. Then set up a certain amount to automatically be transferred to your emergency fund on a regular basis.

2. How much do I need for an emergency fund?

The recommendation is typically three to six months’ worth of expenses. The key is to start small. If building an emergency fund of $50,000 seems overwhelming, start with a goal of $5,000. If you have a higher net worth, you may want to work toward six months’ worth of emergency funds. Again, this figure is based on your expenses, not income.

3. Where should I put my emergency fund money?

You’ll want easy access to your cash when you need it, so a savings account or a premium/high-interest savings account are both suitable.

You can also use a tax-free savings account (TFSA). Withdrawals from a TFSA are tax-free and you can re-contribute any amount you’ve withdrawn, up to the remaining contribution room you have. If you’ve reached your contribution limit, you can re-contribute the amount you withdrew the following calendar year. (Find your contribution room information through the Canada Revenue Agency’s “My account” service.) Just remember to keep the money invested in something safe that allows funds to be withdrawn within a few days or weeks.

4. I have access to a line of credit. Is it still worth having an emergency fund?

A line of credit — especially one with a low interest rate — is a tempting replacement for an emergency fund. It’s there when you need it and you pay no interest if you don’t withdraw any money from it. On the other hand, remember that the interest rate on your line of credit will change whenever the Bank of Canada changes its rate. And while unlikely, the conditions governing your line of credit could also change. 

If you end up going this route to cover emergency expenses, you’ll be racking up additional debt that you’ll be obligated to repay. If you miss any interest payments on your line of credit, that could affect your credit score.

If you’re comfortable with these possibilities, then a line of credit could be used as your emergency fund. This would allow you to apply available cash to paying down debt or making investments, rather than putting it into an emergency fund that would need to be safe and easily accessible (and that usually means settling for low interest on the funds).

5. If I’m in debt, should I pay down my debt before building an emergency fund?

It depends on the type of debt. If you carry a balance on your credit card, paying that down should be your priority since the interest rate is high. For more guidance, see our article Which debt should you pay first during the COVID-19 crisis?

When making this decision, you need to weigh peace of mind against the math. Some may argue that it makes more sense to pay down your mortgage, for example, since the interest saved is likely far greater than what you would earn in an emergency fund.

To others, however, having funds readily available in case of an emergency can be more important than mortgage reduction, especially when we’re feeling uncertain about what will happen in the next few months as Canadian jurisdictions reopen their economy.

A balanced approach may be the best one for you. It’s important to choose the option or options that help you sleep easier.

Talk to an MD Advisor* if you have any questions about building an emergency fund as part of your financial planning.

* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.

The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.