Where to best park your extra money – how to cover debt and emergencies

Firstly, congratulations! You’ve set aside some extra money, and you’ve asked that age-old question – how do I put my spare cash to best use?

And, the answer is – it depends!

‘It depends’ on many things, including your:

1. Age

2. Life stage

3. Future plans and goals

4. Debt and the type of debt

If the extra money is truly excess, perhaps you decide to treat yourself or focus on using it to meet your future plans and goals. But, it may be that there are a few things that you need to take care of first.

Consider an ‘emergency fund’

What’s commonly known as an ‘emergency fund’ is an amount of money that we set aside in a ‘safe’ investment which can be ‘readily accessed’ at any time.

‘Safe’ means that the funds are held in an investment product where there’s a very low risk of loss and with a financial institution where there’s low chance of your money not being there when you need it.

An Insurance GIC (Guaranteed Income Certificate) is an investment product with a low risk of loss. It can only be purchased from an insurance company, which makes it eligible for protection from Assuris, a not-for-profit organization that protects Canadian policyholders if their life insurance company fails. Please refer to assuris.ca for further information.

‘Readily accessed’ means that I can get my hands on it on the day that I need it or within a few days. However, the idea of it being ‘readily accessible’ doesn’t provide you with a license to access it for other reasons, annual vacation, for example. Otherwise, it’s not truly an ‘emergency fund’.

How much should I have in my ‘emergency fund’? Common thinking is three to six months of pay.

Seems like a lot?  So, how do I get there?  Little by little – start, now, by setting aside an amount from your pay every pay and plan to get there in two to three years. (Yes, it’s going to hurt a bit, but it’s worth it!) 

Hypothetical case scenario: Armand lost his job

Let’s have a look at a hypothetical case scenario:

Armand is 30 years old, living in St. John’s, Newfoundland. He lost his job so he had to move back in with his parents. Now, he has a new job. And although he’s grateful to his parents for helping out, he prefers his independence as he had been living on his own since he was 20.

Armand’s decided that he wants to be more responsible about his financial future. After all, his parents are getting older and will soon be retiring. He doesn’t want to be one of ‘those kids’ that keeps going back to their parents for help, since they’ll soon be living on pensions and their life’s savings.

Armand’s new salary is $40,000 per year. His monthly take home pay is about $2,600, after all the deductions. Three month’s pay would be $7,800 – seems like a lot? It is a lot – 25% of his take home pay! How’s he going to get there?

If Armand ‘pays himself first’ and sets aside 10% of his net pay, he will achieve his ‘emergency fund’ goal in 2 ½ years. Ideally, he should aim to save 10% of his pay, before deductions are taken, and then he would get to his goal, sooner. Perhaps this is something he can work towards once he gets started.

This is not only a smart decision, it establishes a pattern of saving, which he can continue to benefit from throughout his life. 

And, it may even be easier than he thinks. He may be able to take advantage of an employer savings program or set up an automatic transfer to a savings account – perhaps with a financial institution, other than where he does his day-to-day banking, making access to his savings a little ‘out of reach’. The idea being if you don’t see it, you don’t miss it. 

Need help to plan a budget? Use this calculator  from the Financial Consumer Agency of Canada.

Address your debt pitfall

Debt is the next item to tackle. It may take priority over the ‘emergency fund’. Yet, again, it depends!  In this case, it depends on the type of debt that you have and the associated costs.

Good debt

There’s good debt and there’s bad debt. ‘Good debt’ is debt that may fall into one of the below categories: This is debt that is used to:

• Pay for your education

• Purchase a home, e.g., mortgage

• Invest in your business or an income-generating investment

However, it is only ‘good debt’ if you can meet your commitment to pay the interest and/or scheduled principal payments on a regular basis and when due, while meeting all other financial commitments, continuously.

Bad debt

‘Bad debt’ is commonly considered to be personal debt that may fall into one of the below categories:

• Payday loans

• Unpaid credit card or charge card balances

• Line of credit

The Government of Canada defines payday loans as ‘a short-term loan with high fees. Payday loans are very expensive compared to other ways of borrowing money’.¹ It warns about the use of payday loans to pay for ‘ongoing costs such as rent, groceries or utility bills’ and states that ‘the cost may be equivalent to an interest rate of 500-600%’.¹

For more information about payday loans refer to Financial Consumer Agencyof Canada.

Consider first paying off your payday loans. Then, you may want to get a complete understanding of the nature and cost of these loans, as well as try to understand other potential options before you access any such forms of borrowing in the future.

Credit cards and charge cards are frequently used for consumable items with, arguably, no lasting value. Such cards charge high interest rates. For many credit cards, annual fees may apply, and the purchase interest rate is often 19.99%². This form of debt is very costly. So, if you have an unpaid debt on a credit card or charge card, consider using any extra money to pay down and pay off the balance in full as soon as possible. Then, commit to only using your credit card for amounts that you know you can pay in full each month by the balance due date. 

To understand the cost and time period over which you can pay off your credit card debt, see the Credit Card Payment Calculator³, Financial Consumer Agency of Canada.

A line of credit should likely also be paid down, even though the rates of interest are generally lower than charged on the above types of debt. Be aware of what has caused this debt. Try to understand the reason(s) for the debt, such as spending on ‘wants’ versus ‘needs’. Cutting back on some of those discretionary purchases will help you towards your goal of being debt free.

Other avenues to build your financial future

What else might you do with extra money in hand? Here are some examples,

• Update or draft your will. This will simplify your affairs for your intended beneficiaries and ensure that your affairs are handled according to your wishes – not the formula-based approach outlined under provincial and territorial succession law – and, potentially, in a more tax efficient way.

For obtaining help in updating a will, refer to article 7 legal documents to have ready at retirement

• Make a charitable contribution to a qualified registered charity. This will benefit a cause, and it may elevate your well-being. You will save tax when you claim the official donation receipt received from a qualified Canadian registered charity on your tax return.

For a list of organizations that can issue an official donation receipt refer to the  Government of Canada.

• Purchase life insurance – this can serve to benefit loved ones following from your death.

• Purchase long-term disability insurance and/or critical illness insurance – these may protect against future loss of income earning capacity.

Cash affords us options. Finding a way to save more money, may be as simple as asking the question when considering a purchase, is this a ‘need’ or a ‘want’. Speak with an advisor or a financial planner to help you put some positive strategies in action to meet future plans and goals.

Read the second article of our series: setting up financial goals for a bright future.