Common personal finance knowledge states that a typical emergency fund should contain three to six months of living expenses. This money helps cushion the blow of unfortunate events like job loss or having to replace a car. But it’s one thing to hoard a bunch of cash in a savings account, and another to know that exactly how far your money will stretch in an emergency situation. Enter: crash testing your finances.
I started doing this shortly after I built my very first “baby emergency fund” with just $2,500. Back then, I was still trying to pay off my debt so I didn’t want to have a lot of cash tied up in a savings account. At the same time, I felt like $2,500 was woefully inadequate when it came to being prepared for emergencies. So I ran some numbers and found out that my meagre $2,500 would get me through about four or five months of joblessness. This was back when I was house sitting a cottage and paying $350 per month in rent.
Since then, every time my financial situation changes, I crash test my finances. I did it when I moved from the cottage to a house (and my rent tripled), and I’m doing again now that I’m living in Halifax (again, a big increase in rent). Here’s how to crash test your finances and find out if your emergency fund is up to snuff, or if a real emergency could put you on the road to a financial crash.
Step 1: Have an “Emergency” Budget
Right now, our monthly expenses total $3,357. That’s our “all is hunky-dory” budget, but that wouldn’t be the case if my husband or I lost our jobs. The first thing I would do is go into extreme frugality mode and start slashing expenses. Some can’t be slashed, some can. I would eliminate our entertainment fund and cut grocery spending by a third. I would eliminate the pet fund and put the animals on cheaper food. I would eliminate spending on home furnishings and travel, and cut down our personal allowances by half.
All together this reduced budget would bring our monthly expenses down to $2,597 (a 22% reduction). Now let’s look at what would happen if my husband lost his job:
Scenario 1: Husband Loses Job
The first thing he would do is apply for employment insurance while job searching. Based on the numbers above, I can cover our monthly expenses, so the employment insurance would just be an added cushion. If he didn’t find a job before his employment insurance ran out, I could still cover our minimum expenses, but the emergency fund would still be there for unexpected expenses like car repairs and vet bills. I estimate we could continue with this budget indefinitely, we just wouldn’t be saving anything whilst he job hunts.
Verdict: We would be fine.
Scenario 2: I Lose My Job
If I lost my job there would be a shortfall in our income to expenses ratio. My husband’s income is almost enough to cover our minimum monthly expenses, but not quite. In this case, I would apply for employment insurance right away, and that income would be more than enough to cover the deficit. Once that ran out, our emergency fund would last us about 2 years or a little less if you factor in unexpected expenses.
Verdict: We would be fine.
Scenario 3: We Total Our Car
Unfortunately, this isn’t a foreign scenario to me. Almost exactly four years ago I was in an accident that left me with a broken wrist and a written off car. Back then I had no idea what personal finance was, I had no emergency fund, and it was horribly stressful. In fact, that car accident was my motivation for getting my money under control. I never wanted to feel like that again.
Today, I could handle another totalled car. Our car is currently worth between $3,000 – $5,000. If it was totalled, I would put that money plus probably another $5,000 from my future fund towards the cost of another car. I’d look for a lightly used car for around $15,000. I’d finance the difference at a low rate, and pay it off as quickly as possible. I wouldn’t have to touch my emergency fund, so even if my husband or I lost our jobs right after our car was totalled, we’d be ok.
Verdict: We’d be poorer, but fine.
A lot has happened in the past year, and we’ve grown accustomed to spending a lot more money. The last time I ran a financial emergency preparedness drill, our monthly spending was only $2,166 per month, and now it’s much higher than that. Because of this, I thought we might have a harder time making ends meet if bad things were to happen. But it turns out we’d be just fine, for two reasons:
- Just because we spend more, doesn’t mean we need to spend more. Our monthly budget is bigger, but our core expenses are still pretty low, so slashing is possible if necessary. We’re not house poor and we own our vehicle outright, this keeps fixed expenses low.
- With his new job, my husband is making more money than ever before.
So the verdict is that we’d be fine through most of the common disaster scnearios, but this exercise also highlights a few weaknesses in our preparedness plan. We both have a year of disability insurance through work, but we could both stand to beef up that coverage through private insurance. Critical illness would also be good coverage to have, beyond what is provided in our benefits packages. Still no need for life insurance though, since we have no dependents and no mortgage.
Have you crash tested your finances recently? What did you discover?