Having a rainy day fund to help cover expenses in case of an emergency is sage advice in the best of times. The financial prescription is even more relevant today amid the economic fallout from the COVID-19 public health crisis.
The rule of thumb to set aside three to six months’ worth of living expenses appears to be spot on as millions of Canadians face a cash crunch due to a loss of income from widespread business closures and the subsequent stock market meltdown.
For financial advisors, it’s an opportunity to remind clients why having some cash set aside is a good idea.
“The importance of an emergency fund is more obvious now,” says Jeet Dhillon, vice-president and senior portfolio manager at TD Wealth Private Investment Counsel in Toronto. “COVID-19 has made things real. It’s showing everyone what can happen.”
A rainy day fund is widely considered to be money outside of the market that’s easily accessible, such as cash in a savings account, shorter-term guaranteed investment certificates and, for some, money market funds.
“You always need to have money on the side that you can dip into for those unexpected needs so that you don’t have to touch your long-term investments,” Ms. Dhillon says. “In times like these, we’re seeing how [a rainy day fund] comes in handy on a wide scale. … This is exactly the purpose for which it was set up.”
For those with little or no emergency savings right now, Ms. Dhillon recommends setting aside money saved from eating out at restaurants less due to physical distancing measures as well as cancelled trips and events.
“It’s a good time to reflect on your cash needs and put money aside,” she says.
Ms. Dhillon also recommends putting rainy day funds into a separate account, adding to it when possible and not withdrawing from the account until it’s needed.
How much to set aside in a rainy day fund will depend on a person’s financial plan and risk tolerance, says Adam Laird, vice-president and principal at HighView Financial Group in Toronto.
Some investors are more cautious and prefer to put away a big chunk of their assets in cash and equivalents while others see it as a lost opportunity to grow the funds through investing, he says.
“The answer is often somewhere in between,” Mr. Laird says. “It’s comfort and confidence. If you plan in advance and have an appropriate asset allocation in place, the rainy day fund shouldn’t be enormous. It’s there to defend the [financial] plan from a derailment.”
The danger of having little or no emergency funds available is that clients may have little choice but to pull their assets out of the market if they need money in a pinch. And if it’s during a bear market, that could come at a loss. It’s a situation some investors are finding themselves in today due to the economic impacts of the COVID-19 crisis.
“That capital loss can be detrimental to a client’s financial plan and investment portfolio,” Mr. Laird says.
While many advisors have cash and cash equivalents set aside in portfolios to prepare for market downturns, the COVID-19 event is likely to rekindle client conversations about how much of an emergency fund is enough, says Tony Maiorino, vice-president and director, head of RBC Wealth Management Services in Toronto.
“When something like this happens, you have a lot of people – including companies and governments – doing an analysis of whether they were prepared properly,” he says. “A lot of people had this vision that, if something really bad happened, we have contingencies and backups, … but I don’t think everyone thought about eight to 12 weeks of people working from home, offices being empty and businesses being shut.”
When the economy is doing well and the markets are rising – as they did for more than a decade before COVID-19 hit – the challenge for many investors is watching their emergency fund sit idle.
“The toughest part is seeing that fund and thinking, ‘I’m never going to use it. It’s just sitting there, so I’m going to use it for that vacation or that car’ – and then boom, here we are,” Mr. Maiorino says. “Discipline around that rainy day fund is key.”
Given the financial impact many investors are feeling as a result of the pandemic, Mr. Maiorino expects emergency funds to be a bigger topic in the future.
“I believe people will start to see more value in maintaining a bit more of a safety cushion going forward,” he says. “But we also have short memories. How long that will last is unclear.”