You consider yourself money savvy: you’ve set up automatic contributions to your RRSP, you’ve socked away some cash for an RESP, and got a budget to make sure there’s enough to cover your expenses each month.
If you’ve done all that, you’re in a great position financially, but you may still be missing one important thing: a rainy day fund.
There are two approaches to a rainy day fund: one considers a rainy day fund to be interchangeable with an emergency fund. The other treats the two separately.
An emergency fund is recommended to be enough to cover your expenses if you find yourself in a dire financial situation.
“An emergency fund is there to help you in times of an emergency. A job loss, your car breaks down, your refrigerator breaks, things you have to deal with ASAP,” says Joe Snyder, Product analyst with Tangerine Investments.
The rough rule that many financial experts suggest following is saving three to six months of living expenses. Exactly how much you want to put away is up to you.
“Say you lose your job and you need to supplement that income, ideally you should be able to do that,” says Snyder. “Having one month is probably not enough, having 12 months is probably more than you ever need.”
A rainy day fund, on the other hand, covers more minor bumps in the road that can come up unexpectedly. Things like your dog needing a visit to the vet, your relative falling ill and you have to fly out to them at the last minute, or your child needing a new computer for school could all merit a “rainy day” expense. Comparatively these are all important things, but you wouldn’t want to eat into your savings for more catastrophic emergencies.
While a single emergency fund could cover all these expenses too, having a separate fund can help protect those three to six months of expenses, so if you do have a more catastrophic financial problem a month after that vet visit, you don’t find yourself short on your rent.
Regardless of whether you use emergency fund and rainy day fund interchangeably, you do need at least one financial reserve that you can turn to when you really need it. A recent poll by Forum Research, conducted following the rate hike by the Bank of Canada, found that 26 per cent of respondents had no emergency savings, and 40 per cent had a cushion of one month or less.
“If you have an emergency come up that’s a couple thousand bucks, what are you doing?” Snyder asks. He points out that loans and withdrawing from an RRSP early can be costly alternatives to pulling from an emergency fund.
If you’ve already got an emergency fund established, your rainy day fund may end up created out of circumstance.
“Say you saved up for a vacation next year, and you wanted to save $3,000-$4,000, but then that trip got cancelled. If you already had an emergency fund, and your plans all of a sudden change, now this can be “rainy day” money,” suggests Snyder.
Once you’ve got money earmarked for your rainy day fund, the next big decision is where you should keep it. Snyder suggests keeping the money in a conservative savings account, housed in a TFSA. That way, you can still earn a little interest on the money without having to pay taxes on the gains down the road. But it’s not worth putting into GICs, because you can’t keep adding money to it, nor a more volatile investment vehicle.
“Because your goal with an emergency fund is to have it there when you need it, I don’t recommend savers take risks with that money,” says Snyder. “The goal is that you have it there, not to make money on it.”