Balance Junkie » Saving

5 New Year’s Resolutions that are Good for Your Wallet

2 Cents — Fri, 06 Jan 2012 10:45:49 +0000

The following is a guest post with some good advice to kick off 2012. Enjoy!

The New Year is upon us, and for many, this time of the year signifies a time of new beginnings. People strive to better themselves by creating New Year’s resolutions, many of which are focused on health. While trying to be a better person in the new year is nothing to scoff at, there are a few New Year’s resolutions that are good for you both physically and mentally, as well as financially.

Losing Weight

Obesity is one of the greatest epidemics plaguing America today, making losing weight one of the most popular New Year’s resolutions this year. However, losing weight isn’t just ideal for your health, it is also highly beneficial to your wallet. In addition to saving money with reduced eating out and grocery bills, losing weight will also save you money longterm as it will provide you with lower health insurance premiums and keep you from suffering expensive medical conditions, such as diabetes.

Going Green

Going green has been on nearly everyone’s mind in recent years, and many are choosing to live more sustainably this year. While some aspects of going green aren’t always cheap, such as new solar paneling, everyday switches, such as switching to CDLs, adding weather stripping to doors and windows, and lowering the thermostat, can actually save you money while you help the environment.

Quitting Smoking

Smoking is in no doubt an expensive habit. Regular smokers can find themselves spending upwards of $200 a month on cigarettes, and even more so in the future should they begin to suffer from one of the numerous health conditions associated with smoking. By quitting smoking, you can save over $1,200 a year alone in cigarettes, and even more down the road by avoiding high medical bills.

Finding a Better Job

There is no doubt that millions of American’s are fighting for new jobs, whether it be selling car insurance or selling real estate, but that doesn’t mean that you should skip out of hunting for a new job yourself in the new year. Finding a new job can not only provide you with a better salary, but also with health insurance and 401(k) match that can provide you with thousands of extra dollars in the future.

Skipping the Coffee Shop

Caffeine is one of the most addictive, a socially acceptable, chemicals in our culture today, and it’s not uncommon to hear someone say, “You don’t want to see me before my morning coffee” or “I really need a Diet Coke right now.” However, that being said, caffeine is also a highly detrimental and expensive habit. The morning coffee that you grab on your way to work or that soda that you get at lunch can quickly add up. So by choosing to give up caffeine in the new year, you will be sure to save yourself a couple hundred dollars.

Everyone wants to get off on the right foot in the new year, and choosing the right New Year’s resolutions is a great way to do so. Just make sure that when you choose your resolutions that they are doing more for you than just making you feel like a better person – make sure that they will also increase your monthly budget too.

TFSA Contribution Limit for 2012

2 Cents — Tue, 15 Nov 2011 10:45:29 +0000

Simplicity is the ultimate sophistication.

~Leonardo DaVinci

When the Tax Free Savings Account was introduced in Canada in 2009, it was hailed for its practicality and simplicity. Any Canadian 18 years or older can now contribute up to $5000 per year to a TFSA and have those savings grow completely tax free. While TFSA contributions are not tax deductible, you will not have to pay any tax on the money you withdraw from your TFSA.

You can put just about any type of investment in your TFSA, or choose a number of different TFSA accounts for different purposes. You could simply have a TFSA savings account, or you could open a TFSA brokerage account whereby you could include stocks, bonds, ETFs or just about any other type of investment vehicle. Whether you earn interest, dividends or capital gains on your savings, your money can be withdrawn tax free. Sounds pretty simple eh?

A Few Asterisks

While I love TFSAs as an alternate savings vehicle for Canadians, they aren’t always as simple as we’d like them to be. I guess that’s just how these things go. Life is complicated. No matter how much we’d like to simplify things, there are always details, exceptions and little asterisks to contend with. TFSA rules are no different.

There has been some confusion over what happens to your TFSA contribution room if you withdraw your gains as well as your original contributions. We addressed that here in January. The latest question peppering search engines seems to be about the TFSA contribution limit for 2012. Why the confusion? Aren’t we allowed to contribute another $5000 each year?

Inflation Indexation for TFSA Limits

In addition to any unused contribution room from other years, you are usually allowed to contribute an additional $5000 per year. You may notice that there’s sometimes a little asterisk (*) next to this figure because it is indexed for inflation in $500 increments. That means that when the inflation rate applied to that $5000 causes it to rise above $5250, the government will raise the limit to $5500.

The consensus seems to be that if the CPI (Consumer Price Index) runs around 2%, that would mean we should exceed the threshold as of 2012. While that looks likely to happen, the CRA hasn’t officially announced the 2012 TFSA limit as of initial publication of this article. I spoke to someone at CRA last week and they said that the official determination hasn’t been made yet, but that it will (obviously) be out by the end of 2011. He advised us to keep watching the CRA website for TFSA updates. (Update: The CRA has left the TFSA contribution limit at $5000 for 2012.)

With the latest Canadian CPI numbers showing inflation running over 3%, it’s hard to imagine that the TFSA limit for 2012 will not be raised to $5500, but we will find out for sure within the next couple of months. I’m sure that many Canadian financial websites will carry the news once it breaks.

For Math Geeks Only

In case you’re wondering about the details of how inflation indexation is applied to the $5000 contribution limit, I thought I might include a chart* here that shows the calculations. It’s actually very simple math. For this example, I’m using a sample annual inflation rate of 2%. *I shamelessly copied this chart from Gordon Pape’s book on Tax-Free Savings Accounts.

Given that the inflation rate is not static, I’m not sure exactly which CPI rate the government uses. They could use an annual average of the monthly inflation data. I’m also not sure whether they use the headline CPI rate or the core rate, which excludes food and energy.

If you follow the chart, you can see that the cumulative inflation factor just adds 2% to the figure from the previous year. So 2% of $5000 is $100 and that is added to the $5000 amount from 2009. For 2011, you just take 2% of $5100 (which is $102) and add it to the 2010 figure like this:

2011 Cumulative Inflation Factor = $5100 x 1.02 = $5202

Since the cumulative inflation factor will put our $5000 over the $5250 needed to round it up to the next $500 increment in 2012, it seems likely that the TFSA limit will indeed be raised for that year. Again, this example is for demonstration purposes only. I’m not sure exactly which CPI rate the CRA will use. If anyone can enlighten us on that, I’d be most grateful.

I hope this answers some of the questions floating around out there regarding the 2012 TFSA contribution limit.

Update: The CRA has left the TFSA contribution limit at $5000 for 2012.

Your comments are always welcome.

Introducing Finizi: A New Financial Tool for Canadians

2 Cents — Mon, 19 Sep 2011 09:45:28 +0000

Starting today, there’s a new financial resource for Canadians out there. It’s called Finizi. Basically, Finizi is a free online service that allows financial institutions to compete for your business. At this time they are only offering GICs, but there are plans in the works to offer competitive bidding on rates for car loans and mortgages as well.

How It Works

Basically, you just need to go to finizi.com and:

1. Request a GIC rate

Select the type of GIC you want and specify the amount you’d like to invest.

2. Financial Institutions Bid for Your Money

Review your bids in a live auction environment. Financial institutions bidding for your business may include credit unions, trust companies or chartered banks. So far, they have about 5 institutions on board, but many have said that they would be interested in joining once the platform is up and running. You are notified when the auction closes.

3. Choose a Winner

Finizi will show you the top 3 rates for the auction and you can choose an in-branch or online fulfillment process. Once you choose the institution and rate you prefer, the winning bank will contact you to complete the transaction.

There is no cost to you as the customer. The bank just pays Finizi a finder’s fee. Finizi doesn’t collect money or sell the GICs directly. They simply facilitate the auction.

Win Win for Banks and Customers

Finizi provides a low cost means for financial institutions to acquire new customers. You may enjoy your GIC experience so much that you decide to use that institution for other products as well. There are no fixed costs associated with using the service, so the bank only has to pay Finizi for closed transactions. This is a great way for banks to take advantage of the huge move toward online banking with very little risk or cost.

For customers, this is just an extension of the increasing move to online financial transactions. The auction model is designed to increase flexibility and transparency for financial consumers – no more shopping around for the best rate. This way, banks can compete for your business and you can complete the whole process online from the comfort of your home if you like.

You can learn more about Finizi by visiting their website or you can watch an interview with Finizi founder and CEO Daniel Shain. If enough financial institutions avail themselves of this technology a great competitive marketplace for Canadians could emerge. It’s great to see Canadian entrepreneurs at work! Congratulations to Daniel and his team and best of luck with this new venture.

(Disclosure: I have no financial or business interest in this company, nor was I compensated in any way for writing this review.)

What do you think of this new way of buying GICs?

RRSP vs. TFSA: One Last Dip into the Debate

2 Cents — Mon, 21 Feb 2011 10:45:11 +0000

The test of a first-rate intelligence is the ability to hold two opposed ideas in the mind at the same time, and still retain the ability to function.

~F. Scott Fitzgerald

Update: Thanks to Arjun at Investing Thesis for including this article in the Canadian Personal Finance and Investing Carnival #16.

Very few topics elicit the kind of virulent debate that the TFSA vs. RRSP argument has generated in Canada this RRSP season. To be honest, those of us who cover finance are probably a little tired of writing about the TFSA vs. RRSP war. I’m sure a lot of readers don’t care to read about it anymore. And yet we (including me, apparently) just can’t seem to let it go. (The RRSP deadline for the 2010 tax year is March 1, 2011, so it should be over soon. )

For years, the RRSP was the stalwart, and really only, widely available tax deferral tool for the average Canadian. Rarely did it come under any real criticism in the mainstream media – until the TFSA came along. Now we see articles almost daily comparing the two. If you point out the short-comings of RRSPs, you can expect a rebuttal accusing you of being an RRSP basher or of “railing against” RRSPs as if you had lost control of your senses. Others will just come right out and say that you’re stupid. Now that really advances the conversation.

On the other side, those who staunchly defend the virtues of RRSPs are sometimes accused of being old-fashioned or in the pocket of the financial industry. Really? Some citizen blogger who works in a completely unrelated industry is conspiring with the Bay Street elite? As a Mom, this is the point at which I would step in between my sons and say “Come now boys. Let’s put this in perspective.”

How about a Little Perspective?

Let’s face it. Those of us who are knee-deep in the nitty-gritty of these financial issues can get a little carried away arguing over the details. To most people, it’s pretty obvious that both RRSPs and TFSAs are great savings and tax management tools for Canadians. Perhaps Jim Yih put it best in his recent article: TFSA or RRSP: Why Not Do Both?

The average Canadian is probably not interested in who’s right or wrong on the most minute details of either product. They just want to understand how they work and how they apply to their personal financial picture. There are some really good basic comparisons out there. Young and Thrifty recently posted a very comprehensive head to head comparison of the two. I wrote a TFSA vs. RRSP comparison last year too. If you’re interested in a little more detail, Larry MacDonald pointed out a few pitfalls to watch out for in 13 RRSP Blunders.

It can also be helpful to read about how other Canadians are choosing to allocate their savings. Paul Brent recently asked me how my family was handling the TFSA vs. RRSP quandary for a Globe and Mail article asking Why Choose a TFSA over an RRSP? The point of the article was simply to give some examples of scenarios where you might choose to top up your TFSA before, or instead of your RRSP.

When you couple the brief quotation in that article with an article I wrote more recently on 5 Reasons to Skip the RRSP Contribution this Year, it’s easy to see how some might put me in the RRSP-basher camp. To be clear, no one has done that to my knowledge. Still, I thought it might be helpful if I spelled my our current thinking on TFSAs vs. RRSPs vs. paying down debt.

Our RRSP Strategy

One area where I do sympathize with the RRSP critics is that I think we need to make sure to remember that we will pay a withdrawal tax when we initially draw down our RRSP accounts, and that the amount of tax we ultimately pay on those withdrawals won’t be finalized until we file our taxes for the year of the withdrawal. It’s important to realize that anything you take out of an RRSP is treated as ordinary income, whether it came from your deposits, capital gains, dividends, or interest income.

On the other hand, TFSAs don’t provide the up-front tax deduction that RRSPs offer. In 2009, we happened to receive a one-time deferred compensation payment from a former employer that would have boosted our income beyond the highest tax bracket. We put some of that money toward our mortgage balance and the remainder in an RRSP. We were able to simultaneously pay down debt, reduce our tax burden, and shore up our retirement savings. This is a good example of an instance where the RRSP makes a lot more sense.

We also maxed out our TFSAs in 2009, the first year they were offered. During the period from 2008 to 2010, our income was uncertain as my husband changed jobs a few times. The money in the TFSA provided a cushion in case of further volatility in our income.

We put a little more money into our TFSA in 2010, but nothing in our RRSP. Our income wasn’t as high, and we chose to put almost all of our disposable income into paying down the mortgage. In 2011, we will pay down the mortgage first, since we don’t have much left owing on it. Next, we will need to contribute to our sons’ RESPs. Two of them will turn 16 this year, so next year is the last year we can contribute for them and still receive the 20% CESG kick.

Larry MacDonald’s article made a good point about the perils of paying down your mortgage at the expense of saving for retirement. We felt OK pursuing this strategy now because we already have a decent emergency fund saved as well as a good start on retirement savings. If we had nothing saved for retirement, we probably wouldn’t be as aggressive about paying down our last remaining debt.

For me, the hardest part of deciding whether (or how much) to contribute to an RRSP in a given year is trying to guess what the future might hold. How will our current marginal tax rate compare to the one we’ll pay in retirement? If our income hits the upper tax brackets in a given year, we will certainly take advantage of the RRSP tax deduction. In addition, Mr. Cents will be eligible for the company RRSP plan this year, so we’ll take advantage of their offer to match monthly contributions up to a certain level as well.

The Bottom Line

TFSAs are better than RRSPs for some Canadians in some years. RRSPs are the better choice for some Canadians in some years. For the majority of Canadians in most years, a little of each is probably a good idea. Declaring a winner is so much less important than understanding how both vehicles work and more importantly, how best to apply them to your own circumstances each year.

How are you handling your savings this year?

(Photo Credit: Feng Yu)

TFSA: Investment Gains, Withdrawals and Contribution Room

2 Cents — Mon, 10 Jan 2011 10:45:31 +0000

Money often costs too much.

~Ralph Waldo Emerson

Update: This article was included in the 13th Canadian Personal Finance and Investing Carnvial posted at Investing Thesis. Thanks!

As if earning enough money to live wasn’t hard enough, we have to figure out a way to put enough aside for the days when we are no longer earning income. Even more arduous is the task of finding the best vehicle for growing that money. And then there are the taxes . . .

In Canada, we have a new product that is supposed to help defray some of our tax burden. The Tax Free Savings Account became available in 2009 and was considered to be a simple, efficient way for Canadians to save money and avoid paying taxes on the growth of that money. I love TFSAs and I think they’re a great product for everyone. They do seem pretty simple on the surface, but, as always, the devil is in the details.

Capital Growth, Withdrawals, and Contribution Limits

Last year I wrote about TFSA Withdrawal Rules, giving some examples of how they work. In the last couple of weeks, however, I’ve received a lot of questions from readers on how capital growth affects your TFSA contribution room. One reader asked this question:

“If I contribute in 2009 – $5000.00 and in 2010 $5000.00 and in 2011 – $5000.00 for a total of $15,000.00 and say this summer of 2011 it has grown to $75,000.00 and I take out the $75000.00. Is it true that in January 2012 that I can put back $75,000.plus the 2012 $5000.00 for a total of $80,000.00.“

Another reader had a similar question:

“I am also curious about something about gains. I contributed the max $10K in the first two years but doubled it through investing. If I withdraw $20K in 2010, does that mean I can contribute back the $20K in 2011? Someone told me that even if the max contribution over the next 5yrs is $25K, if you build the account to $100K then that is the limit of the account. In other words, if I withdraw $100K in year 6, I can contribute back $105K in year 7. Does this make sense? (naturally the growth numbers are fictional)“

When I tried to verify the answers to these questions, I realized why so many people were asking them. None of the examples on the CRA (Canada Revenue Agency) website address this directly. So I called CRA. The gentleman I spoke to basically looked up the information in the TFSA guide and said that the best way to figure out your contribution room is to just follow the formula given by CRA:

The TFSA contribution room is made up of:

• your TFSA dollar limit ($5,000 per year plus indexation, if applicable);

• any unused TFSA contribution room in the previous year; and

• any withdrawals made from the TFSA in the previous year, excluding qualifying transfers.

The $5,000 TFSA dollar limit is indexed based on the inflation rate. The indexed amount will be rounded to the nearest $500. For example, assuming that the inflation rate is 2% for 2009 to 2011, the TFSA dollar limit would be $5,000 for 2009, 2010 and 2011, but would increase to $5,500 for 2012.

Doing the Math

Scenario #1: Investment Gains

Taking the first reader’s scenario into account, the contribution room calculation for 2012 would look like this:

2012 TFSA Limit: . . . . . . . . $ 5500 (Remember the inflation indexing kicks in in 2012, hence the extra $500)

Unused Contribution Room from 2011: . . + $ 0 (Note that unused contribution room can be negative if you over-contributed in previous years.)

2011 Withdrawals: . . . . . . . + $75 000

2012 Contribution Room: . . . . . $80 500

In terms of the second reader’s question, he is correct. If you contributed a total of $10 000 in the first two years (2009 and 2010) and by tremendous skill or luck doubled that money, you could withdraw the $20 000 at the end of 2010 and contribute back the $20 000 plus your $5000 for 2011. He is also correct, in theory, that if you grew the account to $100 000 in 5 years, you could take that $100K out at the end of the 5 years and recontribute it starting the following January.

I qualified this explanation with “in theory” because this scenario assumes that there were no other withdrawals and no over-contributions. Also, it may not be entirely correct to say that your contribution limit has permanently grown to $100 000 because you could sustain investment losses down the road that would reduce the size of the TFSA. Let’s look at an example that includes some investment losses:

Scenario #2: Investment Losses

Suppose, as in Scenario #1, that you had contributed $5000 per year in each of the first 3 years (2009, 2010, & 2011) for a total of $15 000 in contributions. However, instead of growing the account by 5 fold as in our extremely optimistic first case study, you sustained a substantial 33% loss. Ouch. Your TFSA would then be worth about $10 000 instead of $15 000. If you withdrew the entire $10 000 in 2011, here’s what your 2012 contribution limit calculation would look like:

2012 TFSA Limit: . . . . . . . . $ 5500

Unused Contribution Room from 2011: . . + $ 0

2011 Withdrawals: . . . . . . . + $10 000

2012 Contribution Room: . . . . . $15 500

Note that this contribution room limit is lower than what your limit would have been if you had not sustained any losses. An investor who had contributed the maximum $5000 in the first three years and (in theory) incurred neither gains nor losses would have $20 500 in contribution room: $5000 for 2009-2011 plus the inflation indexed $5500 for 2012.

Final Thoughts

The examples above are very simple. Your personal scenario may be more complicated if you have done any transfers or over-contributed at any time. If you really want to know what your contribution room is, you’re best to just do the math following the CRA formula. You can also get TFSA contribution room information from your My Account page on the CRA website or from the CRA’s T.I.P.S. telephone service at 1-800-267-6999. From the CRA website:

“The Canada Revenue Agency (CRA) will determine the TFSA contribution room for each eligible individual based on information provided by you and the TFSA issuers. Your TFSA contribution room will be shown on your income tax notice of assessment or reassessment.“

You could just look for your contribution room on your notice of assessment, but if you want to do some planning ahead based on different scenarios, it’s good to have an understanding of how these limits are calculated. If you want more information, you can find the TFSA pamphlet on the CRA’s site in HTML or PDF format. I hope this helps those who have been wondering about this.

Your comments are always welcome.

GIC Strategy: Two Important Questions

2 Cents — Wed, 13 Oct 2010 09:45:39 +0000

To decide is to walk facing forward with nary a crick in your neck from looking back at the crossroads.

~ Betsy Cañas Garmon

Update: This article was included in the 279th Carnival of Personal Finance – 80s Music Edition posted at Dough Roller. Thanks!

I’ve received a couple of questions from readers on how exactly I have allocated our GIC portfolio. Previously, I’ve written about how set up a GIC ladder, but in reality the numbers don’t always work out as neatly as they do in the examples. The idea behind a GIC ladder is to diversify your interest rate exposure. You can do this by owning GICs with durations of 1-5 years or simply buying a new 5-year GIC each year and rolling money back into 5-year GICs as they mature.

The hope is that you can take the confusion of trying to guess where interest rates are headed out of the equation. But what if you are unable to contribute equal amounts each year to a new 5-year GIC? What if your financial situation isn’t quite as smooth as the ones in the examples?

Interest Rate Confusion

Interest rates are always difficult to predict no matter how much you know about economics and finance. The fact is that no one knows what will happen, so we need to try to include multiple scenarios in our planning process. Having said that, I do believe that the current environment is quite unique in that interest rates are, for the most part, at record low levels. Given that, it would be easy to predict that rates have nowhere to go but up.

The flip side of that argument, however, is that rates have already been low for quite some time and there is a chance that they could remain low much longer. You will recall from our biflation discussion that there are strong deflationary forces present in our economy even while inflationary influences like rising commodity prices continue to exert influence as well. So inflation levels aren’t currently very helpful in determining the direction of interest rates.

Given the bipolar economy with which we are faced, it seems prudent to plan for a couple of different scenarios:

Interest rates could remain low, or even move lower, for some time to come.
Interest rates could spike much higher if monetary policy triggers inflation and/or currency wars.

It’s easy to get caught up with predictions like these: “Well, I think deflation will keep rates low in the near term, but the Fed will cause hyperflation down the road.” That may very well be true, but unless you know exactly when rates will begin to rise, it’s very difficult to allocate your capital perfectly. Alternately, such predictions could easily prove to be completely incorrect.

So what’s a GIC investor to do? I don’t have the perfect answer, but I can offer you a couple of really important questions. These are the questions I ask myself before I invest in anything, including GICs:

A. What was I thinking?

B. What if I’m wrong?

Our GIC Allocation

As I mentioned in our Q3 Financial Plan Update, I recently added to our GIC portfolio. Previously, we had most of our RRSP in a savings account because we wanted that money to be liquid in case of emergency. Our income situation was quite uncertain and we wanted to have that money available as a nuclear option if things really went downhill.

Since then, things have firmed up for us, so I felt better about allocating more of that money to GICs in order to gain a few more basis points of interest income. Here’s a rough before and after snapshot of our RRSP cash allocation:

Before

Savings Account: 75%

5-Year (September 2014 @ 3.00%) GIC: 12.5%

5-Year (May 2015 @ 3.25%) GIC: 12.5%

After

Savings Account: 14%

5-Year (September 2014 @ 3.00%) GIC: 12%

5-Year (May, 2015 @ 3.25%) GIC: 12%

5-Year (August 2015 @3.25%) GIC: 25%

2-Year (August, 2012 @ 2.5%) GIC: 25%

1.5-Year (February, 2012 @2%) GIC: 12%

What Was I Thinking?

When I bought these new GICs, I wrote down my rationale. This way, if my strategy doesn’t turn out well, I will at least have some idea where I went wrong. Here’s what I wrote in August:

“Wanted to lock in these rates as bond yields have been falling. Deflation (perhaps for a number of years) is possible. But if inflation occurs and rates rise sooner than I think, we have some cash to put to work, and some shorter-term GICs maturing within 1.5-2 years. If we get some kind of really quick interest rate spike, we still have the option of early redemption.”

So for better or for worse, that’s our plan. You can see that it’s not a textbook GIC ladder. For one thing, it’s heavier on both the 1.5- 2-year and the 5-year ends. I chose this kind of barbell strategy because the shorter term rates are still better than what we’re getting in the savings account, but I didn’t want all of the money locked up for 5 years. The 3 and 4-year rates didn’t offer a whole lot more interest than the 2-year. Besides, one of the 5-year GICs is effectively a 4-year GIC because we’ve had it for over a year already.

What If I’m Wrong?

You can see by my rationale that I’ve tried to cover both inflationary and deflationary concerns. My base assumption is that rates will remain low for at least a couple more years – maybe even longer. If I’m wrong and interest rates spike sooner rather than later, we can redeem these and buy higher-yielding GICs. If we redeem before maturity, we will only receive 0.5% interest. Obviously, we would have to look at a cost-benefit analysis to decide whether or not that would be worth it.

The fact is that there is no single correct way to invest in GICs anymore than there is a right way to invest in stocks or bonds. Each of us has to look at our own financial situation and make the best decision we can with the information we have at the moment. Only time will tell whether we made the best possible choice or not. I hope this helps anyone who had questions.

What’s your GIC strategy?

Which Is the Best Way to Save Money?

2 Cents — Wed, 16 Jun 2010 09:45:20 +0000

My problem lies in reconciling my gross habits with my net income.

~ Errol Flynn

Update: This article was included in the Festival of Frugality: Summer Edition posted at Where’s My Rolling Pin? Thanks!

I recently received a request from a doctoral student to fill out a short questionnaire on savings methods. The survey was directed at personal finance bloggers. Two different savings approaches were explained, and then respondents were asked which they would prefer, and to what degree. I wasn’t quite sure if I completely grasped the spirit of each approach, but I answered the questions to the best of my ability.

The two approaches proposed by the doctoral student are the circular savings method and the linear savings method. I’m going to outline both of them as explained by the author here, and I’d be

interested in your thoughts on them.

Circular Savings Method

This savings method involves setting aside a certain amount of money at regular intervals, such as each pay period. The idea is to focus on saving the amount that you want to save now, not next month, and not next year. “The future will be exactly like the present: if you save money now, you will save in the next pay period. If you don’t save money during the present pay cycle, it is likely you won’t save money in the next cycle. We want you to focus on your personal savings in the present”.

If you continue to save money each pay period, you will be able to look back at some point and realize that you’ve accumulated a nice nest egg. This method views life as consisting of “many small and large cycles”. I understood the focus of this approach to be saving regularly to the best of your ability given your current circumstances rather than looking very far into the future and trying to come up with an end goal to achieve.

Linear Savings Method

This method views life as composed of “separate time compartments such as the past, present, and future. We want you to think of the personal savings task as part of such a linear progress. Make your saving task a planned one: just focus on the total amount of your savings goal for the future. Think about discrete savings tasks and do each task one at a time. Do not think about what you have or have not saved in the past.”

If you save money now, you’ll be in a much better position in the future. But “saving is not an action that is the end goal, but rather a means to the more important goal of attaining something which lies in the future, such as your retirement or a better life”.

A Balanced Approach

When I really thought about it, I had to conclude that an approach that incorporates both a linear and circular component would probably serve most people well. The survey asked the following question: “If you had to suggest one of these approaches to your blog’s readers, which one would you choose and why?” My answer was as follows:

I can see some merit in both approaches, but I would likely choose the circular method if I had to choose only one. This method makes saving a habit. I think you might be able to use the two in conjunction if you used the linear method to choose a circular savings amount based on your current resources and time horizon.

For example: You could use the linear method to set short and long term savings targets, and examine areas in which to cut spending, or earn more income in order to achieve those big picture targets. Setting a regular savings amount is key to achieving those goals. This savings amount can be adjusted periodically as your life unfolds, but always saving something is imperative.

Another question posed was: “In your opinion, what are the reasons people use a linear or circular savings method for their savings?” Here’s how I answered that one:

Circular savers understand that regular saving is a good way to maintain a disciplined approach to achieving their savings goals. Linear savers are probably more concerned with the big picture and end goals and less concerned with the details of getting there.

It seems like the linear approach would work better for those who are extremely self-disciplined and are able to keep a close eye on the big picture and the end goals. Unfortunately, many of us do not fit this profile and need regular, circular savings to help us enforce that discipline on ourselves. We tend to live in the present and can sometimes forget about or ignore the future consequences of our present actions.

Perhaps one of the reasons we, as a society, have not been saving enough is that we are using the linear saving strategy, but not carrying out the discrete savings tasks necessary to achieve our goals. Including a circular component to our savings strategy would go a long way toward increasing the overall savings rate.

I like to think of myself as pretty well-disciplined. As such, my approach tends to be more linear. But that hasn’t served us all that well over the past couple of tumultuous years as we haven’t been saving regularly. In the past, our income was extremely variable with a modest regular income punctuated by some fairly consistent and sometimes substantial commission windfalls.

As such, I would plan our savings based on this type of linear progression. We’ve managed to save a decent amount without contributing monthly. Still, I’m reconsidering that approach based on some recent changes. I’d like to add a circular savings component to our financial plans in order to make saving a real habit that we can maintain through good times and bad. I’ll have more on that in the next quarterly update, scheduled for the end of June.

What do you think of these two savings methods? Would you lean toward one more than the other, or would you prefer a combination approach?

TFSA Withdrawal Rules

2 Cents — Tue, 25 May 2010 09:45:37 +0000

The best things in life are nearest: Breath in your nostrils, light in your eyes, flowers at your feet, duties at your hand, the path of right just before you. Then do not grasp at the stars, but do life’s plain, common work as it comes, certain that daily duties and daily bread are the sweetest things in life.

~ Robert Louis Stevenson

Update: This article is included in the Carnival of Personal Finance #259 at A Gai Shan Life.

I love TFSAs. I think they’re the best financial “innovation” to hit the market in a long time. Last week, I wrote a lot about the complexities that have built up, wreaked havoc on, and continue to threaten our financial system.

The beauty of Tax Free Savings Accounts (TFSAs) lies not only in their tax sheltering function, but in their simplicity. The rules surrounding this relatively new Canadian savings vehicle are noticeably sparse in comparison to those surrounding RRSPs and the tax code itself. I’ve previously written about the basics of TFSAs in the context of comparing them to RRSPs. (See TFSA vs. RRSP Duel: Who Wins? for a summary of the basic features of each.)

Today, I’d like to look at the specifics of withdrawing money from TFSAs. Although the rules are pretty simple, things can get a bit confusing, especially if you’re used to dealing with the rules of other financial products. I thought we’d look at a few examples to help make things a little clearer.

TFSA Withdrawal Basics

You can withdraw any amount from your TFSA at any time without paying tax on the principal or any accumulated investment gains. It’s your responsibility to track your contribution room limits, although the CRA does mention your limit on your Notice of Assessment. You don’t have to set up a TFSA or file a tax return in order to start gathering TFSA contribution room. You just have to be at least 18.

The main thing to be aware of when you withdraw money from your TFSA is that you can’t put the money back until the following calendar year. If you put it back in before the end of the same calendar year and that causes your total contributions for that year to exceed your contribution room limit for that year, you will have to pay 1% per month tax on the excess contribution amount.

Example 1

John opened a TFSA in 2009, the first year they were available. He contributed the maximum amount ($5000). In 2010, he was eligible to contribute another $5000 and he did so in January of that year. In March of 2010, John learned that he would be temporarily laid off. He withdrew $4000 from his TFSA, anticipating that he would need the money during his layoff.

A few weeks later, John’s employer landed a contract that meant he would be called back to work after only 2 weeks off. John wanted to put $3000 back into his TFSA, but would be unable to do so until January 1, 2011 since he had already contributed his $5000 limit during 2010. If he was unaware of this rule and contributed the $3000 back anyway, he would be subject to the 1% per month tax until the end of 2010.

Assuming he understood the rules and held off on replacing any of the money he withdrew, John’s contribution limit for 2011 would be $9000. ($5000 for his regular 2011 contribution amount + $4000 to replace his 2010 withdrawal.)

Example 2

This is an example of how I used the TFSA withdrawal rules to manage our finances recently. If you’ve been keeping up to date with my quarterly planning reports, you know that we have experienced quite a reduction in our income level over the past 2 years or so due to my husband’s recent (and frequent) job changes. As a result of a potential budget shortfall this year, I felt that we might need to draw down some of the savings in our TFSAs.

In anticipation of this, I took some money out of each of our TFSAs at the very end of 2009. I did this to ensure that we could replace the money in 2010 if possible. If I had waited until January of 2010 to take the money out, we might not be able to replace that money until 2011.

For example: At the end of 2009, I took $5000 out of my husband’s TFSA, leaving only the accumulated interest in the account. (Note that investment gains and interest are not treated as contributions.) As a result, his new contribution limit for 2010 is $10 000 ($5000 for 2010 + $5000 from the 2009 withdrawal.) If I had waited and withdrawn the $5000 in January, his contribution limit for 2010 would only be $5000.

So technically, if all we wanted to do was to be able to replace the original $5000, we could have done so using 2010′s contribution room. However, now we have the option to contribute an extra $5000 if we are able to do so. Who knows? Things are looking a little better for us than they were at the last quarterly update. Tune in at the end of June for more details!

Note that there were some changes proposed in October of 2009 that would make some withdrawals ineligible for replacement in the following calendar year. However, most of these pertain to transactions by more sophisticated investors intended to game the system and take advantage of the relatively low 1% over-contribution tax. Frugal Trader offered a good review of these proposed TFSA changes at Million Dollar Journey.

If you have any questions or comments on TFSA withdrawals, please leave them in the comments section or send me an email.

10 Ways to Save on Insurance

2 Cents — Thu, 29 Apr 2010 09:45:34 +0000

I believe that thrift is essential to well-ordered living.

~ John D. Rockefeller

Updates: This post was chosen as the winner in the Best of Money Carnival #49 posted at Canadian Finance Blog. Thanks Tom! It was also included in the Carnival of Personal Finance #255 at Well Heeled.

Recently, Canadian Capitalist wrote about Auto & Home Insurance Premiums Going Up In Ontario and Rob Carrick lamented the sizable increases in home insurance premiums. Insurers are telling us that they are paying out more in claims and that their costs are rising. There’s not much we can do to get them to lower their premiums, so we might as well control what we can. Here are 10 ways to save on insurance:

1. Bundle & Save

Many insurers will give you a discount if you insure more than one asset with them. Ask how much you’ll save if you insure multiple vehicles as well as your home with the same insurer. If you have a boat, RV, cottage, or other insurable assets, be sure to throw them in the mix as well to maximize your savings. If your insurer doesn’t provide these discounts, see #2.

2. Shop Around

If you are looking to insure a new car or home, check with your existing insurance provider first, but then call around to other companies to see if they can do any better. We like to repeat this each year a few weeks before renewal. We have been with the same company for a couple of years now, but we only found them as a result of shopping for a better rate than our previous insurer was offering.

3. Raise Your Deductibles

You can call your insurance company at any time and ask them to raise the deductibles on your home and auto insurance. We have raised our home insurance deductible to $1500 and those on our vehicles to $1000 each. This can add up to some pretty nice premium savings over a couple of years. Just make sure that you always have enough cash on hand to cover the deductibles just in case. We earmark a part of our emergency fund for this purpose.

4. Purchase Wisely

If you’re buying a home, it will cost less to insure a newer home as it’s less likely that things might go wrong with your electrical, heating or plumbing systems than if you own a home with antiquated structures. Also consider the geographical location and construction of the home. Is it in an earthquake, hurricane, or tornado prone area? If so, you may want to make sure the home is built to withstand those conditions.

When purchasing a vehicle, it makes sense to get an insurance quote before you buy. All other things being equal, you may want to choose the vehicle that is cheaper to insure. The Insurance Bureau of Canada offers information on How Cars Measure Up in terms of insurance claims. The data only seems current up to 2008, but you should be able to get a general idea on how expensive various vehicles are to insure. You may also want to avoid vehicles that are more likely to be stolen.

5. Ask for Discounts

Insurance companies offer discounts for a variety of situations and they can vary greatly from company to company, so make sure you shop around for the company that offers the discounts that best fit your situation. Here are some of the ways you might be able to qualify for a discount:

Have a great credit rating. Yep. That can actually save you money on your premiums with some companies.
Pay off your mortgage. Make sure you let your home insurance provider know once you do, and you could be in line for a premium discount.
Seniors discounts
Good student discounts for teens and young adults with good grades: this group can use all the help they can get, as their premiums (especially for males) are usually a lot higher.
Alarm or theft deterrent discounts
Discounts for belonging to professional or community associations
Over 45/mature driver discounts
Discounts for good driving record
Loyalty discounts for remaining with the insurer
Claims free discount
Short commute savings: premiums are usually lower if you drive your vehicle less.

6. Pay Annually

Check to see if you are being charged a financing fee for paying your premiums more than once a year. If so, save in advance and pay the premiums annually.

7. Pay for Smaller Claims

If you have a small claim to make, you’re probably better off paying for it out of pocket and leaving the insurance company out of it. For one thing, if you have raised your deductible as suggested, your claim might not be eligible. You will also be susceptible to a boost in premiums and lose your “claims free” discount. Save the insurance for the big problems.

8. Reduce Coverage

Be careful with this one. You want to make sure you have the insurance coverage you need when you need it. Still, there are a couple of things to consider that could help save you some money: If you own an older vehicle (some say 5 years or older, and others say 7), consider removing the collision insurance from your coverage. The idea here is that, if your car is damaged in an accident, it will likely cost more than the car’s value to repair or replace it. In this case, you’re better off avoiding the insurance hit and buying a new car. (Just make sure you have some money saved in advance to do so.) One other consideration is that, if you have a loan outstanding on your vehicle, the lender may require you to carry collision insurance. Make sure you check with them before you make a change.

9. Check the Details

Each time you receive a policy renewal, it’s good to make a habit of checking to ensure that details like your name, address, policy numbers, and V.I.N. numbers are correct. If you’re insured for the wrong vehicle it could be costing you money. There may be a tendency for your eyes to glaze over when you look at your insurance policies (I know mine do), but it’s worth taking a few moments to review any additions the insurance company has included. Last year, our company added rental car coverage to our policy, so I called and asked them to delete it. That saved us $60 a year for two vehicles.

10. Prepare & Prevent

You can keep your premiums low by reducing the likelihood that you may need to make a claim:

Drive safely. Getting there a few minutes sooner just isn’t worth it.
Install smoke detectors in your home and check the batteries at least twice a year.
Install an alarm system and use common sense to practice theft deterrence.
Have a fire extinguisher at the ready in your kitchen.
Maintain your home and your car: taking good care of your assets will make them last longer and may prevent more costly problems down the road.

Can you think of any other ways to save on vehicle or home insurance?

GIC Primer: Frequently Asked Questions

2 Cents — Fri, 09 Apr 2010 09:45:15 +0000

If you don’t like something, change it; if you can’t change it, change the way you think about it.

~ Mary Engelbreit

Update: This post is featured in the Money Hackers Carnival #111 posted at Deliver Away Debt. Thank you!

I recently wrote about How to Ladder GICs. That post lead to number of general questions about GICs, so I thought I would provide some information for you here. Although GICs are among the safest and simplest investments out there, there are enough options surrounding them to make choosing one almost as confusing as choosing other types of investments.

Why Invest in GICs?

Guaranteed Investment Certificates can offer investors a safe place to invest a portion of their capital. Depending on the length and features of the GIC you purchase, they can provide some liquidity as well. In general, GICs are much safer than stocks, although many would argue that you can earn more in stocks over the long term.

GICs can act as a risk balancer for your portfolio. Although stocks can provide higher returns over certain periods of time, those returns are never guaranteed and your individual return on investment will depend on a whole host of variables over which you may or may not have some control. GICs are of course, by definition, guaranteed.

Are GICs a Safe Investment?

Yes. The only time your GIC money would truly be at risk would be if you had stepped outside of the CDIC boundaries for insuring GICs (and your financial institution failed). The CDIC insures money invested in GICs on terms of 5 years or less up to $100 000 per eligible institution per person. That means that you could theoretically have up to $100 000 in GICs at one institution in each of 3 accounts: one in your name, one in your spouse’s name, and one joint account. The entire $300 000 would be CDIC insured. For more on different scenarios, check out the CDIC’s Deposit Insurance Calculator.

One other concern is that you need to make sure that you choose the right term and product features. If you think that there’s a chance you might need the money in a year or two, don’t invest in a 5 year non-redeemable GIC. As always, it’s important that you understand what you’re buying.

Where Can I Buy GICs?

GICs are offered by banks, credit unions, trust companies, and some brokerages. They are usually free to purchase, although some brokerages charge a commission on GICs. (My brokerage is Questrade and they charge a $30 + GST fee for purchases and early redemptions. ) You can find the best rates by surfing the net or consulting an RDBA (Registered Deposit Brokerage Association) member like Fiscal Agents.

Is There a Minimum Amount I Need to Invest in a GIC?

It depends on the specifics of the product you are buying. Some providers have no minimums and others are as low as $100. Check with your bank or broker before you buy. Some institutions will offer higher interest rates for larger investments, but be careful that you don’t exceed your CDIC limits.

How Are GICs Different from Bonds?

Bonds are basically I.O.U.s. You lend money to a government or corporation in exchange for a certain coupon or interest rate. There are two main components to a bond: the price and the yield. The price and resulting yield of a bond can fluctuate daily as they are traded on the open market. But this will not affect you unless you sell your bond before it matures.

GICs are not traded daily like bonds. There is no price or yield fluctuation. The only factors that might affect your return are the terms of the GIC itself. Sometimes there is a penalty for early redemption.

Are GICs a Good Place to Put My Emergency Fund?

The purpose of an emergency fund is to have liquid cash ready to deploy as needed. While many consider GICs to be a portion of the “cash” part of their investment portfolio, they are not quite as liquid as cash in a savings account. It depends on the terms of the GIC you purchased. Some short-term GICs are cashable, but you can usually get a better interest rate with a high interest savings account.

Some folks elect to keep the smaller “what if my dishwasher dies” portion of their emergency fund in a high interest savings account, but the larger “what if I lose my job” part in a portfolio of laddered GICs. In the end, the choice is yours and it will depend on your individual situation.

Can I Put GICs in My RRSP, TFSA, or RESP?

You can hold GICs inside RRSPs, TFSAs, and RESPs as long as those types of products are offered by your institution. If your RRSP or RESP is with a big bank, they pay very low interest rates on GICs. Most online discount banks pay higher GIC rates, but don’t offer RESPs. Only a few of them offer RRSPs so far.

Keep an eye out for higher promotional rates on RRSPs and TFSAs, as they are often available at select times of the year. (For those who read the Globe and Mail Me & My Money feature, my 90-day RRSP GIC at 3% recently matured and I rolled it back into my savings account, as that rate was no longer available as of April 1st, 2010.)

Which Term Should I Choose?

You can usually choose a term of anywhere from 30 days to 10 years. If you choose a term over 5 years, your GIC will not be CDIC insured. If you choose a term under 1 year, your interest rate will often be lower than what you could get in a high interest savings account. (Unless you can find a really sweet special rate somewhere!)

How Will Taxes Affect My GIC?

If you hold your GIC outside of an RRSP, TFSA, or RESP, your income on the investment will be taxed as interest income. There is no additional tax on the principle amount invested as that was already taxed as income. GICs inside RRSPs are like any other RRSP investment: they are not taxed until you take money out of the RRSP. At that point, you will pay tax on whatever money you withdraw at your marginal rate.

If you take any money out of your TFSA, it’s tax free. That means that the interest you earn inside a TFSA (unlike in an RRSP) is truly tax free. RESP withdrawals are more complicated and beyond the scope of this already-too-long post. Check out Four Pillars for some very comprehensive information on RESPs.

How and When Will I Receive My GIC Interest?

This can vary greatly, so it’s something you definitely want to note when you’re shopping for GICs. Some GICs will be structured to pay interest monthly, quarterly, or yearly. Pay attention to the way interest is calculated as well. For example, one GIC might compound interest monthly or even daily and pay it out quarterly. Another product might compound interest annually and pay it out at maturity. The key is to thoroughly understand how interest is compounded and how it is paid before you buy. Don’t be shy about asking as many questions as it takes.

What Happens When My GIC Matures?

This is something you need to determine with your provider. In general, you may have the option to roll the money into a GIC of the same term, a GIC of a different term, or a savings account. Alternatively, you could take the money out and spend it. Just make sure the money is going where you want it to go once the GIC matures, and set it up in advance.

What if I Need the Money Before My GIC Matures?

This is a critical question to ask your provider. Generally, the more access you have to your money, the lower the rate you will receive. Some GICs are cashable, and others are not redeemable at all. Some offer early redemption with a penalty. That means if there is any chance you might need that money before the term is up, you need to make sure that you can access it, and that you’re prepared to accept any applicable penalties.

Do you have any questions that I didn’t cover here? Are GICs a part of your investing/savings strategy?

High Interest Savings Accounts for Canadians: BJ Guest Post

2 Cents — Wed, 31 Mar 2010 12:52:01 +0000

I have a guest post today at bankshout.com on High Interest Savings Accounts for Canadians. If you’re interested in some tips on Canadian banks that pay higher interest rates and online banking in general, please check it out!

How to Ladder GICs

2 Cents — Tue, 30 Mar 2010 09:45:38 +0000

You’ve got a lot of choices. If getting out of bed in the morning is a chore and you’re not smiling on a regular basis, try another choice.

~Steven D. Woodhull

Update: This article is featured in the Money Hackers Carnival #110 at Planting Dollars. Thanks!

I recently wrote about how CDIC protection makes GICs one of the safest investments. Whether you decide to devote a substantial chunk of your portfolio to GICs, or just a small portion, it pays to think about how you want to allocate your GIC investments. Which terms should you buy? How much should you put into each? A GIC ladder might be just what you’re looking for.

You can usually receive a better GIC rate than those offered by the big banks by consulting a deposit broker. It’s a good idea to make sure that the broker is registered with the RDBA (Registered Deposit Brokers Association). They can provide you with information about the services provided by deposit brokers in Canada. Generally, these services are free to you.

You may have noticed Fiscal Agents listed in the resources section here on Balance Junkie. They are a deposit broker. I don’t have any affiliation with them, nor have I used their services. I included their site here because they have some really neat tools there.

Alternatively, many online banks offer GIC rates that are much higher than the big Canadian banks. Most will offer them as TFSAs as well, although only a few online banks offer them under the RRSP umbrella. The convenience of banking online can be a big plus too, especially when it comes to dealing with GICs as they mature.

GIC Ladder: Step By Step

There are a few different ways to set up GIC ladders. I’m going to give you the most common one here.

Step One: Decide how much of your portfolio you want to allocate to GICs. (For this example, we’ll assume you have $25 000.)

Step Two: Divide the amount from step one by 5. ($25 000/5 = $5000)

Step Three: Set up 5 separate GICs with terms that range from 1 year to 5 years. (You will put $5000 each in a 1 year, 2 year, 3 year, 4 year, and 5 year GIC.)

Step Four: When each GIC matures, roll that money into a new 5 year GIC. (Each year, you will have a $5000 GIC (plus interest) maturing. Use that money to buy a new 5 year GIC.)

Ladder Variations

Roll into Consistent Terms: When each GIC matures, you would roll that money into the same term again rather than into a 5 year term. So if your 3 year GIC was maturing, you would buy another 3 year GIC. If you do the math on this, it usually doesn’t pay as well as the standard 5 year roll outlined above. That’s because interest rates on 5 year term investments tend to be higher. (In general, the longer the term, the higher the rate.)

Roll into a Different Investment: If you needed the money from the maturing GIC, you could spend it, or you could invest it anywhere else. You could buy stocks, ETFs, or bonds. Alternatively, you could roll it into a high interest savings account for safe keeping while you decide what you want to do with it.

Why Ladder Your GICs?

Interest rates can be very unpredictable. What seems like a low rate today could go lower – or not. Interest rates have been declining for about 2 decades now, and it seems like there’s no place to go but up. But you could have said that many times over the past decade or so. I have no idea how long interest rates will remain this low, or how quickly they might rise once they get started.

A GIC ladder can help spread out your interest rate risk by ensuring that you are always invested in a variety of terms. Renewing at 5 year terms ensures that you will always be investing at the highest CDIC-insured rate possible at the time. Remember that if you invest in a product with a term of more than 5 years, it will not qualify for CDIC insurance.

Your choice of GIC strategy should take into account your time horizon. If you are retired, you need to pay close attention to term maturities in order to make sure you will have access to the money when you need it. If you are very young, you can just keep rolling into 5 year terms without much worry about needing the money to live on. If, however, you know you’ll need the money at a certain point in time to buy a car or put a down payment on a house, make sure you have enough money maturing when you need it.

Do you invest in GICs? What strategy do you use? Have you tried laddering?

Emergency Fund FAQ

2 Cents — Mon, 22 Mar 2010 09:45:25 +0000

Prepare and prevent. Don’t repair and repent.

~ Author Unknown

Update: This post is featured in the Carnival of Financial Planning – Edition #135 posted at The Skilled Investor. Thank you!

I’ve mentioned emergency funds quite a bit but I’ve never given them the thorough treatment they deserve. I thought I would try an FAQ (Frequently Asked Questions) format to provide you with some information and options.

What Is an Emergency Fund?

An emergency fund is a reserve of cash that you set aside for unexpected expenses. This usually applies to things that break: your car, your appliances, your furnace or other items in your home – or maybe even an arm or leg. (Sometimes you have to pay for certain types of casts or splints.)

You may also want to build an emergency fund to cover higher future mortgage costs. If you are on a variable rate, you may want to have a cushion in case rates rise. If you have a very low fixed rate mortgage, you may have to renew at a higher rate later. It pays to use a mortgage calculator ahead of time to make sure you’ll be able to cover your new payments.

Why Should I Have an Emergency Fund?

An emergency fund can give you peace of mind and keep you from incurring debt and the extra costs that come with it. You will avoid both stress and interest.

Should I Pay Down Debt or Build an Emergency Fund First?

There is some debate on this issue, but I come down on the side that says you should have at least a minimum emergency fund of $500 – $1000 before you attack your debt. This will keep you from incurring more debt if your dishwasher breaks down or you blow a tire.

If you know your washer and dryer are on their last legs, you may want to save enough to cover a new set. (See my article on Preemptive Purchases.) If your car is likely going to need brakes over the next year, you can save for that in advance too. Once you have paid down your consumer debt, I would suggest padding your emergency fund to protect against job loss.

How Much Should I Save in My Emergency Fund?

Again, there’s a lot of debate over how much you should save. In the end, it’s your call. Once you have saved the minimum amount ($500 – $1000) and paid down your consumer debt, the exact amount you need to save depends on your situation.

If you have a very stable income, you may only want to save enough to cover expenses for a month or two. If your income is variable or you are worried about losing your job, you may want to build up a 6 month cushion, or even more if it helps you sleep at night.

Is your home due for a new roof? What is the life expectancy of your vehicles and appliances? How accident/illness prone are your kids? If you have young children who tend to get sick frequently, you can incur elevated costs for prescriptions and/or over-the-counter medications.

Obviously, you can’t predict every possible expense. That’s sort of the point of the emergency fund. But you can arrive at a better ballpark figure if you have a good handle on what might go wrong. Every year when I set up our budget, I ask my husband for rough figures on car care and home maintenance expenses and then I budget a little above that just in case.

Where Should I Keep My Emergency Fund?

Your emergency fund needs to be easily accessible. We basically have two emergency funds. We keep the largest portion in a high interest savings account. We also keep a cash cushion on hand at home in case we can’t make it to the ATM (or the ATMs are down) or we just need some cash for unexpected expenses like field trips or fundraising for the kids’ schools. I track this cash and it gets replaced as soon as possible.

We’ve held a number of garage sales over the years and I usually use the proceeds of those for the cash portion of our emergency fund. It helps to keep some smaller bills, loonies, and toonies on hand from these sales for school expenses like those mentioned above. (Exact change is often required.) I can’t tell you how many times I’ve been grateful for our garage sale cash box when I’m rooting around for $3.75 for a hot dog day or some other event.

When Should I Use My Emergency Fund?

Your emergency fund should be reserved for true emergencies. An unexpectedly good deal on a vacation package doesn’t count. If you use your fund for things like that, it won’t be there for you when you really need it. If you’ve been around awhile, you know that Murphy’s Law says that you’ll have a fender bender or some other bit of bad luck right after you’ve booked your cruise.

Set some rules for yourself and follow them. Write them down if you don’t trust yourself or your significant other to stay disciplined. When you want to tap your emergency fund, whip out your list of rules and see if your proposed purchase fits. If it does, go ahead and spend the money. If not, you’re either going to have to do without that item or wait until you’ve saved enough to buy it without debt.

If you need to use some of your emergency fund, take some time to re-evaluate your position afterward. You’ll probably want to take some time to replace that money so that you’ll be ready for the next emergency.

How do you handle your emergency fund? Do you have any good tips to share?