How Relevant Is an Emergency Fund?

No, I don’t have an emergency fund.

Don’t throw tomatoes at me, please. I already know all the financial gurus of this world would be outraged.

Actually, I’ve had a funny ongoing thought process about emergency funds. Like any good average Quebecker, I’ve lived from paycheque to paycheque. At the time, I had no spare change between my income and my expenses and, of course, no emergency fund.

Then, when I started getting into personal finances, I followed Dave Ramsey’s baby steps, among others. So, I started by building up a small emergency fund of about $1,000, and then started working on paying off my student loan. Once the student loan was paid off in full, I built a proper emergency fund.

Then, with the influence of the FIRE movement, I began lowering my expenses, increasing my income and investing my savings massively. Suddenly, my emergency fund felt like a dead weight. After the pandemic was declared in Mars 2020, falling interest rates certainly did not help this sentiment. Not long after, I decided to invest the entire thing in April 2020.

Since then, I no longer have an emergency fund. And you know what? I can still sleep soundly at night.

What Is an Emergency Fund?

As for many other personal finance notion, opinions differ widely about the emergency fund, especially its size. However, we often hear about having the equivalent of 3 to 6 months’ worth of expenses in cash or at least easily accessible. Of course, the more unstable our income or employment situation is, the more we need to stack in our emergency fund. For some, it might be safer to have up to 12 months’ worth of expenses, for example.

The goal here is to be able to cover expenses for a certain period of time following hard times or to absorb an unexpected specific expense.

In my case, I have a very stable job with a predictable and secure income. Accumulating more than 3 to 6 months would really be overkill. Currently, my monthly expenses are around $2,000, including my car payments. Therefore, you would expect for me to have between $6,000 and $12,000 in cash, easily accessible. By “easily accessible,” we generally mean a simple savings account.

As always, it’s on a case-by-case basis.

Who Should Have an Emergency Fund

Think about it. Who really needs an emergency fund? Who would be at risk of going bankrupt after a major unexpected expense? Who might lose their home after losing their job?

Ironically, these are the people who live paycheque to paycheque. For them, the slightest problem could very well break down their cash flow. In such a context, an emergency fund is essential. However, since these people are already living from paycheck to paycheck, it is very difficult to build one in the first place.

However, for a person who already regularly saves a large portion of their income, an emergency will not compromise their basic needs.

As mentioned earlier, my monthly expenses are about $2,000 compared to an average monthly income of $3,500. That means I already have a good amount of leeway in case of an emergency.

Opportunity Cost

What I don’t like about the emergency fund is the return I don’t get while the money is not invested. I really like for my money to work for me.

As we all know, interest rates on savings accounts are currently at historic low levels. For example, Tangerine generously gives me an incredible 0.10% interest rate right now.

Of course, I am aware that some online banks offer (temporary) promotions of maybe 1 to 2%. However, this implies that you have to constantly move your money from one bank to another once the promotion expires. Personally, I find that it takes too much time and energy for a meager 1 or 2%.

In a single year, my hypothetical $6,000 to $12,000 emergency fund would earn $6 to $12 in interest in my Tangerine savings account. On the other hand, if it were invested in an index ETF, it could make a much better return. Even with a rather conservative hypothetical return of 6%, I would be making about $360 to $720. That’s 60 times more than my savings account at Tangerine!

Add to that compound interest from one year to the next and the opportunity cost only increases exponentially.

I don’t know about you, but the difference pains me.

Inflation

Add inflation to the mix and I may start to cry. Because while my hypothetical emergency fund is earning its meager 0.10% interest, inflation is wreaking havoc at an average of 2% per year. Probable more in the years to come.

So, if I let my emergency fund sit there too long, it will only lose purchasing power, year after year.

To keep the same purchasing power and have an equivalent emergency fund from one year to the next, I would theoretically have to add to it every year. Each additional amount added each year would in turn be subject to the opportunity cost and inflation.

As you can see, inflation keeps me awake at night more than stock market fluctuations. To me, money that is not invested is 100% guaranteed to lose value.

Can the same be said for money that is well invested in the stock market?

Safety Nets Already in Place

In 2018, I was already questioning the relevance of my emergency fund. In December, more precisely, I was briefly off work after a case of appendicitis. Despite a month without working, I never had to dip into my emergency fund. Indeed, I was lucky enough to have a short-term disability coverage through my employer.

However, even if I didn’t have such coverage, my expenses were low enough to be almost entirely covered by EI Sickness benefits.

This made me start thinking about all the systems already in place for emergencies. You have to think about all these safety nets that you may already have. You’ve probably guessed it, but insurance plays the main part. After all, why do we buy insurance in the first place? Usually, it’s to cover unexpected and random events. In other words, emergencies.

Some examples of such systems include the following:

• Private insurance:
  • Home;
  • Automobile;
  • Loan;
  • Critical Illness;
  • Pets (it’s a thing!);
  • Travel;
  • Etc.
• Group insurance :
  • Short Term Disability;
  • Long Term Disability;
  • Critical llness;
  • Extended Health;
  • Etc.
• Public programs
  • Employment Insurance;
  • The Commission des normes, de l’équité, de la santé et de la sécurité du travail (CNESST);
  • The Société de l’assurance automobile du Québec (SAAQ);
  • Disability Pension from QPP or CPP;
  • Etc.

We cannot deny it. In Canada, we already have many safety nets. Since March 2020, we have even seen how generous our governments can be in times of crisis.

Add to that our own private or group insurance and we start having a lot of backups against emergencies.

Of course, if you don’t have any private or group insurance, then an emergency fund could really be relevant. This allows you, in a way, to self-insure.

What Is an Emergency

Think about it. What could go so wrong in your life that you would have to dip into an emergency fund?

The main emergencies that come to mind are, but are not limited to :

• Job loss;
• Disability;
• A sick family member;
• A major home expense;
• A car problem;
• Veterinarian fees;
• Etc.

We’re really talking about emergencies here. Not Christmas expenses or a can’t-miss discount on a trip abroad.

In short, imagine what kind of emergency could happen in your life. Which of these scenarios would be covered in part or in full by insurance that you already have, directly or indirectly?

Finally, what kind of emergency would you really have to cover exclusively with your emergency fund?

Now, if you didn’t have an emergency fund, would you be able to take pay for it with a credit card or with a line of credit, temporarily? Would you be able to pay it back fairly quickly with your excess cash flow normally dedicated to savings?

Of course, this kind of strategy requires excellent credit management. If you carry a credit card balance from one month to the next and are already choking on astronomical interest charges, this strategy is definitely not for you. In fact, go back to Dave Ramsey’s baby steps.

Finally, if the worst that can happen to you is to temporarily reduce your savings to cover an emergency, you’re really not in such a bad situation.

The Ultimate Loophole

Finally, underconsumption and frugality are, in my opinion, the ultimate loophole to exploit in order to survive an emergency.

Earlier, I mentioned my average monthly expenses of about $2,000. That’s already pretty frugal to some people. However, if a real emergency occurred, I could cut some non-essential expenses (SAQ, Netflix, Spotify, charitable donations). I could also sell my car to pay off my loan in full, in addition to no longer having any expenses related to my car (licence, plates, gas, maintenance). If I brought this down to the bare minimum, it could total about $1,000 in monthly expenses.

Then, in the event of a job loss with EI eligibility, I could have weekly taxable benefits of $595 or approximately $450 net. This would actually be enough to cover my expenses.

What if I lose my job without EI eligibility? With such low expenses, even a minimum-wage job would be enough to support me.

If there’s an urgent expense without job loss (visit to the vet, an appliance broke down, etc.), then the difference between my income and my expenses could easily pay for it.

Keep in mind that having a frugal lifestyle, even if only temporary, can help make a difficult situation much more tolerable.

Worst-Case Scenario

I know that some anxious or pessimistic people tend to imagine the worst.

Thus, they may bring up worst-case scenarios. For example, what happens in the event of job loss, in addition to a critical illness with no insurance coverage?

First of all, I wouldn’t wish that on anyone. Furthermore, anyone facing this kind of situation will not get away with a mere 3 to 6-month emergency fund, unfortunately.

However, Employment Insurance does pay 15 weeks of sickness benefits, and then QPP (or CPP) provides a disability pension in the case of a serious and permanent illness, and this, at any age.

After that, well you might need to dip in your nest egg. But then, at least you do have a nest egg, huh?

More importantly, what are the chances that this type of situation will really happen? No one is entirely protected against that, I agree. However, I don’t see the added value of living in fear of such a scenario.

Like Mr. Money Mustache himself said pretty recently about the advice he would give to his younger self:

Yeah, I thought about that a lot. I do have an answer and it’s just, “You don’t have to worry.”

I lost some sleep over that situation and then I just described and I was stressed out and there was nothing to worry about. In the very-very worse situation, I still have way better financial situation than the average person does today, even with a really good job. […] I think most people, especially analytical people, they just worry too much about everything.

To Each Their Own

I thought long and hard about all of the above before I fully invested my emergency funds last year. With the pandemic, I think we’ve all had to envision many worst-case scenarios. Personally, it made me realize that even in some of the worst cases, I didn’t really feel the need to have so much cash on hand.

So that’s why I don’t have any emergency funds at the moment. This way, I can inject 100% of my savings in the stock market and I don’t have any money that is prone to lose purchasing power due to inflation.

However, I am well aware that this strategy does not apply to everyone. Some people sleep better at night knowing that they have a cash cushion in case something goes wrong. Others have many more variables in their equation than I do that can cause emergencies (children, sick parents, a house or rental properties, etc.). These people have their very own thinking and analysis to do.

In fact, once I reach FIRE, I will probably have no choice but to change my mind. Since my income will depend mostly on the moods of the stock markets, not to mention no longer having a group insurance, I believe that I will sleep better with a certain amount of money set aside.

Ultimately, having an emergency fund has a positive effect on a psychological level, much more than on a financial level. Ed Rempel’s research conclusions explains it perfectly well:

The study showed that holding cash does not protect you. In fact, it often increases your risk of running out of money.

There is an argument that holding cash has a good behavioural effect on investors. With some cash, they may stay invested and avoid the “Big Mistake” of selling their equities while they are down. To the extent this is true, holding some cash may be beneficial for the behavioural effect only.

But cash does not actually protect you. It’s safer not to hold cash.

Considering all of this, I’m aware that I will have to re-evaluate my situation when I get there.

That being said, I would be curious to hear your point of view on the subject. Do you have an emergency fund? How big is it? Have you had to dip into it for an emergency? What kind of emergency was it?

Don’t hesitate to let me know! 🙂

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