For some reason financial gurus the world over are constantly
recommending that everyone have 3 months worth of expenses sitting in a cash
account 24 hours a day, 365 days a year in case a catastrophic emergency comes
up. This sounds like great advice, but really, how often do these situations
occur?
Given the way the world works these days, there are few people who need
to keep large sums of liquid cash sitting in an account earning little to no
interest in case the worst happens. Instead, people should be taking that
money, and investing it in their future. Ideally, we’d all be debt free, and if
not, why not save yourself the interest on a loan, or even worse a credit card,
by directing that money to your highest cost debt. This way, you’ll reduce your
interest payments, and reduce the impact of compound interest to get out of
debt that much faster. If you are debt, or at least consumer debt free, take
that extra money and start saving for your retirement. Get your money working
for you in a TFSA or RRSP, investing in your future and taking advantage of
compound interest.
If the worst were to happen, and you needed access to money for the
short term, why not get rewarded for that spending, and use a credit card
interest free for your applicable grace period, (usually 21 days). If you’ll
need that money longer than 21 days, pay off your credit card with a line of
credit, ideally linked to your mortgage to reduce your interest costs. The idea
here is that any interest you might pay on a short term loan as a result of an
unexpected lack of income or is more than made up for by the long term
investment gains you’ve made while your money is sitting in your TFSA or RRSP.
This strategy only works if you don’t use your available credit unnecessarily.
In order to remove the temptation, ensure that your loan isn’t available from
your debit card. In this way, you’ll have to make the conscious decision to go
to your lender and physically ask for access to your loan.
This strategy works best if you have access to credit at a reasonable
interest rate, for example, prime plus .5%, which most people should be able to
secure on a HELOC when they negotiate their mortgage. If you can’t get, or
don’t want to have a loan available to you, then at least use your TFSA to getting
your money working for you while keeping it sheltered from the tax man. If you
are using a TFSA, make sure to watch out for contribution limits, and be aware
that if you are lucky enough to have a fuller TFSA, if you withdraw money this
year, the contribution room is not available again until next year.
As a final point, I want to be clear on what the purpose of having
access to funds in an emergency. You should be using this money to pay your
mortgage, rent, and other necessary household expenses. That’s really it.
Buying new clothes, eating out, entertainment, etc, should get saved until your
financial crisis is over. Tough times require that you really watch every penny
to ensure that you spend responsibly in order to ensure that you get back on track
as quickly as possible. We all keep our fingers crossed that we never need
access to these funds, but it would be unreasonable to assume that it won’t
happen to us. This is the same reason we have insurance, to protect ourselves
from the unknown and unexpected.
