Why an Emergency Fund should be your first financial priority

In the personal finance community there is a lot of debate about emergency funds vs. debt repayment and which you should focus on first if you’re trying to fix your finances.  Some experts say that, if you have debt, then debt repayment should always be your first priority.  For example, in his Baby Steps program, Dave Ramsey has advocated starting with a $1000 emergency fund and then moving on to pay off all of your debt (save for your mortgage) before saving a more substantial emergency fund of 6-9 months of living expenses.  On the other hand, I’ve seen many other sources, such as The Financial Diet, arguing that saving a substantial emergency fund comprised of about 3-6 months of living expenses should come before focusing entirely on debt repayment.

The argument for prioritizing debt repayment is pretty simple: debt is a huge barrier to financial freedom and you should get rid of it as quickly as possible.  This is especially true if a lot of your debt is high interest consumer credit card debt.  I agreed with this philosophy when I first got interested in sorting out my finances because the debt that I had was feeling like a heavy burden: I wanted it off my shoulders immediately.  While paying off my credit card debt I had been saving a small emergency fund and had about $3000 put away.  In a particularly antsy moment, I withdrew $2500 to finish paying off my credit card.  Unfortunately, almost immediately after I did this, I was diagnosed with cancer and needed to take time off work.

This situation left me with no credit card debt, but also with nothing set aside to tide me over while I was off work.  I had some understanding of this risk when I was making the decision, but at the time I thought the risk was minimal at worst.  I was living at home, where most of my major expenses were covered, and I had a stable job that was paying me a decent wage where, if I was careful, I would be able to save up a nice chunk of money quite quickly.

But then, as I mentioned above, I got sick, was hospitalized, and then I was diagnosed with cancer.  If I had been careful, the $3000 that I had saved could have lasted me 6 months or more, since my expenses are now so low.  Due to my emotional spending at the holidays and some unexpected medical expenses, I now have that amount sitting on my credit card and only a little money in the bank.  My government Employment Insurance sickness benefits ran out in early February, so I don’t have any income to fund my current expenses or begin paying off the debts that I have incurred since being diagnosed.

Obviously this is not an ideal situation.  If my long term disability claim is denied, this will turn into a very bad situation and, as such, I have completely reversed my opinion on emergency funds vs. debt repayment: saving an emergency fund should always be your first priority.  Debilitating illnesses or accidents can happen at any time to anyone.  It doesn’t matter if you work out and eat blueberries and kale and meditate every day, they can still happen to you.

I know that saving 3-6 months of living expenses probably seems like a lot of money, especially if you have debt.  It is a lot of money, but it’s good to keep in mind that your day-to-day expenses should be reduced in emergencies.  You’re not looking for 3-6 months of net pay, but 3-6 months of keeping a roof over your head, keeping the lights on and paying your most basic bills.  It’s also important to remember that if you don’t have money set aside for an emergency and you wind up in a situation similar to mine, you’ll likely wind up incurring further debt and risk putting yourself in serious financial jeopardy.  If you don’t have savings and you don’t have a steady paycheque, credit cards might be your only option.

Regardless of what happens with my disability application, my plan for the future is to never wind up in a situation like this again.  Lesson learned.  I can’t wait to get better and get back to work so I can start executing my financial plans and saving the substantial emergency fund that I have envisioned for myself.  In the meantime, I’ll just have to take it all one day at a time and see what happens.

Finance Post: My Money Philosophy

A few months ago I purchased a financial advice book called Why Didn’t they Teach me this in School by Cary Siegel.  There is an accompanying workbook with exercises meant to assist the reader in learning more about personal finances.  In order to use my free time a little better and to get the most out of writing again, I have decided to blog the exercises from this book that I think are useful to me.  Some really are decent blogging prompt.

Exercise 1: “Write about/discuss your money philosophy.  Are you a spender or a saver? If someone gave you $10000 to spend on whatever you want, what would you do with it?”

It should probably be said right from the start — I am notoriously bad at managing my money and I have always been a spender, to my detriment.  My family was well off and inclined to spoil me, so as a child I never wanted for necessities or luxuries.  We went on nice vacations, I had lots of toys and lessons and sports and books to read.  I never had to worry about money.   As a teenager, this trend continued.  My parents were what you would now call “helicopter” parents.  They were strict and wanted to exert a significant amount of control over my life: part time jobs were not allowed.

Unfortunately, my lack of experience with money as a child and adolescent didn’t serve me particularly well.  I didn’t learn money management through osmosis and, once I started working and had to manage money on my own, I had no idea what I was doing.  When I finished school and started earning more from a full time job, things just got worse: I spent every cent I had and more.  When I started work on my Masters degree in 2006 I paid off my max-ed out credit card ($5000) on my new student line of credit, and then continued to spend irresponsibly.

More debt cycles followed and only over the past year or so have I been trying to live below my means.  I am working hard to transition from being a spender to being a saver and to develop more frugal living habits.  I do still want to enjoy my life, however, so I am a little more relaxed with my budget than I think some would be in my position.  I am particularly fortunate that I don’t have to pay any major living expenses at the moment, which is allowing me to pay off debt quickly and save a little bit without worrying too much.

This month I will finish paying off my credit card (which was maxed out at $8,000 earlier this year).  After that, I will be moving on to paying off my latest student loan (currently sitting at $18,200).  It is my hope to be completely debt free by June of 2019, though hopefully I will manage it several months earlier.

I think it’s fairly obvious, then, that if I received $10,000 that I could spend on anything I like, I would use it to pay down my student loan debt.  While the urge to spend and treat myself is strong, getting a 10 month head start my current plan would be incredible.  The sooner my loan is paid off, the sooner I will be able to save at least one full paycheck per month.