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Saving for a Rainy Day

How to Prepare for Life’s “What Ifs”

Let's face it, with all our other financial obligations, how many of us actually set aside money for life's contingencies? Most of the time, we're simply doing our best to meet the bills and mortgage payments and contribute to our retirement savings plan.

And then there are the psychological challenges: When work is going well, the finances are in order, and you're otherwise enjoying yourself, building a "rainy day" fund is probably the last thing on your mind.

But that's precisely when you should be setting aside some money for life's "what ifs."

Despite our best-laid plans, life can sometimes toss a curveball our way. An unexpected job loss, a disability, an urgent roofing job on the house — any of these can throw our finances out of whack.

So, just as you save for longer-term goals such as retirement by contributing to an RSP, it's also smart to prepare financially for whatever life brings. Read on to learn:

Whether it's called a "cash reserve," "emergency fund," "what if fund," or "rainy day fund," many financial planners recommend that we have enough cash on reserve to cover at least three to six months of living expenses — groceries, the rent or mortgage, utilities, phone, transportation, and other necessities.

The amount that you should be saving will depend on your personal circumstances. If you’re single, have a secure job, and your skills are in high demand, you can probably get by with three months on reserve. Be realistic about your ability to replace regular income if something were to happen to your job.

If you have dependents, or your income fluctuates because you work on commission or are self-employed, it's a good idea to build a larger emergency fund. In fact, some people prefer to save three to six months' salary, as opposed to simply covering the necessities.

Although it may be tempting to tap into your RSP to cover an unplanned expense, in most cases that would be a mistake. You'd have to pay tax on that amount and you'd lose the benefit of compound growth.

Tip: No matter how secure your job may seem, it's a good idea to keep your résumé, skills, and list of potential employment contacts up to date. The days of a "job for life" are long behind us.

You'll want the money you put away to be completely secure and accessible. So it shouldn't be in stocks or stock mutual funds — they can produce solid returns over time, but they tend to fluctuate in the short term.

GICs are secure, but you may have to lock your money in for a while. Although a bank account would do the trick, there are ways to earn better rates of return.

Money market funds or high-interest savings accounts are options for your savings fund. You'll earn a more competitive rate of interest, and the savings are secure and always accessible.

Tip: If you are carrying high-interest debt, such as credit card balances or department store credit, it makes good financial sense to pay that off before building your reserve fund.

  • Determine the amount you’ll need to cover your family’s expenses for three to six months. Numerous budgeting tools available online can help. For some budgeting tips, see our articles on "How to budget for life: Part I and Part II."
  • Work out what you can afford to set aside each month.
  • Then, start socking the money away. And what's the best way to do this?

If you have some cash sitting in a bank account that is not being used for any other goals, you can draw from those savings to start your fund. If you don't, a regular savings plan is an excellent way to build your reserve fund.

Let's say you've decided to put $100 a month into your emergency fund. Arrange to have that money automatically transferred to your savings fund from your bank account — say, at the middle of each month — through a pre-authorized contribution plan. Think of it as paying a bill to yourself.

Pre-authorized contributions are a convenient, disciplined way to build your reserve fund. The actual amount that you’re earmarking for your fund each month is not the important point; after all, it may take you a few years to reach your target. More important is setting aside the money on a consistent basis and tapping into it only when you need it.

Once you’ve reached your savings target, you can continue to use pre-authorized contributions to meet other financial goals — good habits, after all, are hard to break.

Tip: Unfortunately, a disability is an all-too-common cause of income disruption. A reserve fund can help see you through a disability, but it's just as important to get proper insurance — especially if you are self-employed and not otherwise covered. Even salaried employees may find that their group insurance plan provides limited disability coverage.

Building a reserve fund doesn't have to be difficult, and it doesn't have to be done overnight. Following the simple steps outlined above can help you prepare financially for any unexpected challenge that life throws your way.

Points to keep in mind

Save at least three to six months of living expenses
Regular saving is the best way to build your reserve fund
Try to pay off high-interest debts first