Start Building Your Rainy Day Fund

Every person needs a fund to tide them and their families over in the event of an emergency. Unfortunately, about 45 per cent of the country doesn’t have one.

Where Do You Find the Money? In theory, most people concede that a savings cushion is a great idea. In practice, however, many wonder where they are going to find the extra money to park in an account where it will simply sit waiting for a “what if” scenario to turn into reality. The following eight suggestions can help you get a start on building a contingency fund relatively quickly and nearly painlessly: 1. Consider monthly savings as a bill that must be paid. To help, have the money automatically transferred from your chequing account or your paycheque. 2. Depending on the size of your family, skipping one meal in a restaurant each week could generate about $200 a month, or $2,400 a year. Look at your other spending habits. There are likely several “extras” you buy that you could do without for awhile. 3. Put at least half of your next pay raise, bonus or tax refund into your contingency fund. You won’t get used to the money so you won’t miss it. 4. When you pay off a car, a loan or your mortgage, redirect half the extra money to your savings. 5. Do you really need two cars? If you can live with just one, apply the monthly savings to the fund. You could also trade in your car for a smaller, less expensive model or a used vehicle and save the difference. Keep in mind, these actions can be temporary. Once you build your fund, you can regroup and reconsider your vehicle needs. 6. Round up to the nearest dollar each purchase you log into your financing software or your chequing account. If you spend $35.10, log it in as $36.00. You wind up thinking you have less to spend but in reality you are saving small amounts that add up. 7. Set a higher budget high for groceries than you actually spend. If you typically spend $350 to $375 on food, budget $400 and bank whatever you don’t spend of the amount you budgeted. 8. Save your coins and small bills. At the end of each day, dump into a jar the change in your pockets and the $1 bills in your wallet. At the end of the month you can bring a fair amount of savings to the bank. Your adviser can help you come up with many other simple techniques to stop spending and start saving almost effortlessly.

Generally it is a smart precaution to have relatively liquid funds available that could cover from three to six months of budgetary expenses. The higher your net worth, the more you will need in your fund. Once you tap into the funds, be sure to replenish them.

So, why do you need this emergency fund? Because life is full of surprises. A contingency fund helps you to protect your most important assets during a crisis such as losing your job, becoming disabled for a time, needing a new roof, replacing your furnace when it gives out during a cold snap or being hit with a large tax bill just as your estimated quarterly payment is due.

Because contingency funds are meant for non-recurring expenses, you need to be able to access the money quickly. However, if you tend to be a spender, put the money into an account that requires a little effort to tap and don’t get a debit card attached to the account.

The challenge is how to invest the money in a way that it can be liquidated quickly without any major tax consequences. That means you shouldn’t expect to park your money in a high-yield account.

Contingency funds generally are not put into a long-term investment. You also want to ensure the money goes into a safe investment. The whole point of this fund is not to make a profit but to have it in a vehicle that can be cashed in within a day or two. So the best solution is likely to avoid any stock market or equity risk.

There are several places where you can put this money, none of which generates a high yield:

• Savings accounts keep your money safe and generally are available the minute you need it. But they pay very little interest. Some online savings accounts do require a slight waiting period, a day or two, before you can access the money.
• Money market mutual funds are relatively safe but also don’t offer much in the way of interest. When the money reaches a certain level, you could roll over all or some of it into a CD or Treasury bond. The money might not earn as much, but it is more difficult to access.
• Cashable GICs and bonds can be liquidated quickly and are secure, but again, expect a low return.
• A chequing account overdraft is a possibility, but it should be a last resort. The penalties are generally high, frequently $5 a day for each day the account is overdrawn.
• A secure line of credit on your home is an alternative to a contingency fund. You can instantly access the cash at a relatively low cost and you don’t tie up money in a savings fund. However, you need to maintain discipline and not draw on the credit line for any other reason than a bona fide emergency. And as you soon as you can, start to pay it down to reduce the amount of interest you wind up paying.
• Registered Retirement Savings Plans (RRSP) do not work well in emergency because if you take money out you pay taxes on it and cannot replace it.
• Tax Free Savings Accounts (TFSA) on the other hand, do work. You earn tax-free investment money in these accounts and you could save the equivalent of three or six months’ salary within a TFSA in a secure investment such as a GIC. Then you could access the money quickly without paying tax on the interest income.

In addition, you can recontribute the money you withdraw beginning in the year after you take the money out, so you can replenish any funds you access in an emergency so they starting generating tax-free income again.

A margin account with your broker is another possibility. Many brokerage firms offer these accounts and allow you to borrow from them. There are no tax consequences as long as the money is taken simply as a loan. Taxes come into the picture only if you have a capital gain or loss from selling something to cover the loan. You still don’t incur tax until you sell assets in your portfolio.

Consult with your adviser to work out the best plan for setting up your contingency plan based on your financial situation.