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Friday, November 6, 2009

Emergency Funds

Until recently, I never really saw the need for an emergency fund. Financial experts (and financial book writers) always stressed the need for three to twenty-four months of expenses to have saved in the case of an emergency (like losing your job). Others call it the "sleep well at night factor", that you feel better about yourself and your finances if you have several thousand dollars at hand.

I have started an emergency fund, which I have yet to touch. It will only end up with a few thousand dollars in it at the absolute most, because I have a tough time conceiving an emergency that will cost more than that. Why did I decide to do this? For a few reasons, but mainly because I always feel it is better to be ahead than behind, and my old emergency fund plan would put me behind financially.

What was the old plan? Probably the same as most peoples: credit cards and lines of credit. What I did several years ago was dip into a line of credit or a credit card whenever I needed money, whether it was an "emergency" or not. If I needed money for something, I would either borrow it (from family or my "emergency" fund) and then be behind financially. By just having a few thousand set aside, if I need this money for anything I will just be able to access it.

My old self would say "how can you just leave the money sitting there? Shouldn't you either be using it to pay off a bill or to invest in an RRSP?". My lines of thought have changed that if you don't have at least $1000, the potential for large hits on a credit card or line of credit in a year are inevitable. My money goes into my Tax Free Savings Account, so it is still invested in low-cost mutual funds, so I'm not losing any savings potential.

I give regular contributions to this fund. When I get significantly over $1000 (or whatever number I choose...I am approaching $1000 now) I can then choose to do something with the excess money (an extra pay on my mortgage, a last minute investment in my RRSPs, a down payment on a second property (hint, hint)). By not having an emergency fund, I open myself up to the possibility of constant borrowing, and we all know that you can only get ahead by savings (and investments) rather than borrowing.

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