Building an Efficient and Effective Emergency Fund

One of the fables I remember repeated numerous times during grade school was Aesop’s tale of the ant and the grasshopper. For those of you unfamiliar with the fable, it tells of an ant and a grasshopper living as neighbours. The grasshopper spends the warm months singing and watching the ant toil as it slowly builds up a food store. When winter comes, the grasshopper is unprepared and starves as it watches the ant dig into the stock- pile it has accumulated. The moral of the story preached to me then by my teachers was the value of planning for the future by working hard today and the perils of idleness.  

While this lesson still remains just as relevant, I find myself drawing new wisdom through connections between it and one of the basic tenets of financial planning– building and maintaining an emergency fund. If we go back to the fable again, the ant’s diligent effort in successfully building a stockpile was aided by its knowledge of two important variables– it knew when to expect to use its stockpile and how much it would need. In other words, it knew the timing and the value of its need.  

In comparison, when we look at an emergency fund, only the value of the need can be estimated. To satisfy this need, it is normally recommended to keep 3 to 6 months of living expenses in an emergency fund. But how does one address the timing need? The answer is to ensure that the funds are liquid, meaning they are easily accessible and held in cash or near-cash equivalents. So now, you’re probably thinking, 3 to 6 months of living expenses is a large amount of money, especially if you happen to live in Vancouver, to keep in a savings or chequing account. What’s more, despite doing the right thing, the ant didn’t have to contend with taxes on interest earned or low interest rates!  

One solution to address both these problems is to hold the emergency funds in a high-interest savings account within a TFSA (currently up to the $31,000 maximum). Interest is allowed to accumulate tax-free within a TFSA and withdrawals can be made at any time without being subject to withholding taxes or included as income for the purposes of calculating taxes and other income-tested government programs (MSP premiums, OAS, assisted living). 

Even better, any withdrawals you make in the current calendar year can be added back to your TFSA the following year, meaning you can continue to replenish your emergency funds for future needs. 

A second solution which eliminates the timing need and necessity of holding what could be a large percentage of your net worth in cash is to borrow the emergency funds when you need them. Of course, you would need to ensure the value of the credit facility is adequate, with one added consideration – the interest rate. This eliminates credit cards and most unsecured lines of credit as options since the cost of borrowing this way ranges between 8 – 29%. This leaves one viable option – a secured line of credit. A secured line of credit decreases the risk to the lending institution as something of value is pledged as collateral against the value of the loan, and hence, a lower interest rate can be offered.  

A Home Equity Line of Credit (HELOC) is secured against the value of a home for an approved credit limit at a rate that is usually variable, and depending on the product, can be locked-in for a fixed term. With a HELOC in place, you are now free to use the cash otherwise earmarked as emergency funds for other needs or to be invested in more productive investments which are hedged to inflation.  

Who knew you could learn so much from a grasshopper and an ant? Talk to your Rogers Group Financial advisor for more information to see if these solutions are a fit with your current financial position.