Mary Castillo: How to plan for emergency expenses

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Does saving money for emergencies seem unrealistic when there are bills to pay, food to provide, and children’s activities such as soccer or dance to fund?

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Personal finance experts frequently advise having enough money to cover three to six months of expenses in case you find yourself unable to work. However, given the high cost of living, this advice might seem impractical.

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Here are some of the key facts to consider with different approaches to creating your own emergency plan.

Create a separate emergency savings account

Establishing a dedicated bank account for emergency savings is an approach that allows you to start small and gradually increase your contributions as your budget permits. The process is straightforward: Open a high-interest savings account at your financial institution, then using online banking decide how much you want to transfer automatically into this account each month.

To help keep your money safe from yourself, consider designating this savings account not as chequing or saving but what is usually called by your financial institution the “other” position on your debit card. This way, it remains accessible online but not at a debit terminal during an impulse purchase. If you and your spouse manage money together, or if there’s a trusted individual willing to be a joint account holder, you could set up the account to require two signatures for withdrawals.

A savings account provides easy access to funds when you’re faced with an emergency. Once those funds are exhausted, if you still need financial support, you may need to rely on other savings, borrowing options, or government or employer assistance programs, if you are eligible.

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Use investments to pay for emergencies

If you invest regularly, you might forego a separate savings account in favour of diverse investments, such as a registered retirement savings plan (RRSP), tax-free savings account (TFSA), or non-registered investment accounts. In an emergency, you can evaluate your investment portfolio to determine which funds to withdraw. However, it is important to assess the situation before withdrawal. Review market conditions, penalties and fees, delays in accessing funds, or tax consequences in the case of RRSP withdrawals.

If you have access to a line of credit, you might use it to cover emergency expenses and then, depending on interest rates and returns, decide whether to repay the borrowed money from your investments or increase payments to your credit line once your income returns to normal.

If you prefer to keep most of your savings invested, consider maintaining a small sum of money in a high-interest savings account, equivalent to two months’ worth of expenses. Alongside this, keeping four to six months’ worth of money in a low-risk investment such as a money market fund or cashable guaranteed investment certificates (GICs) can provide a financial safety net. This approach ensures that funds are accessible without incurring big losses when the markets are down.

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Use credit to pay for emergencies

Access to secured lines of credit, particularly home equity lines of credit (HELOCs), has surged with the rise of re-advanceable mortgages. Until the recent rapid increase in inflation and interest rates, HELOCs were an inexpensive and easily accessible source of funds. However, this led to a blurring of the lines between “available cash” and “available credit.” Many people began to view their HELOC as a growing safety net, not realizing that the credit limit is controlled by their lender. Changes in a lender’s policies or the nature of a specific emergency, such as the death of a co-borrower, could result in a reduction of the credit limit and available funds just when they are most needed.

The danger of depending on borrowed funds, such as lines of credit or credit cards, during an emergency is that it’s not your money; control over it lies with the lender. Accumulating debt in an emergency and not knowing when you’ll be able to repay it should be a last resort. However, using a credit line to cover a short waiting period until an investment can be redeemed might make sense if the emergency expense can’t be postponed.

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The importance of having an emergency plan

How you plan for emergencies is a personal decision, and even with combined finances, spouses might have differing approaches. For someone who is stressed living paycheque to paycheque, having a solid emergency savings account can help alleviate money worries, even if it means earning less interest compared with investing. For the spouse who doesn’t need to see a high bank balance, just knowing there’s money available in savings if needed might be comfort enough.

However, it’s always easier to spend than to save. Frequently cashing out investments when you need money can quickly deplete the long-term savings you will rely on for retirement. There is both financial and psychological value in maintaining the types of emergency savings accounts you feel most comfortable with, even if they differ, as long as you and your spouse agree on your overall approach.

The best approach for dealing with emergency expenses is the one that works for you, and it may involve a combination of different strategies. Ultimately, savings protects us from financial uncertainty, and you can’t put a price on peace of mind.

Mary Castillo is a Saskatoon-based credit counsellor at Credit Counselling Society, a non-profit organization that has helped Canadians manage debt since 1996.

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