A plan to determine your rainy day fund

The term “budgeting” isn’t appealing and it sounds restrictive.  So let’s call it planning.

Most successful businesses have a plan.  In some cases, these are five year plans that are updated annually.

The focus of a basic plan is to determine how much you are currently spending on a monthly basis.  When you go through this process you should determine if the expenditure is a basic need or a discretionary item, which is really not needed.

Planning is especially important for couples with limited income.  The process of sitting down and preparing a plan should help open the lines of communication when it comes to finances and what you define as a basic need or a discretionary item.

Here are some steps:

1.  Keeping track of all income, payments and expenditures.  One of the easiest ways to begin preparing your budget is to review previous deposits, pay slips, bank transactions, cash payments and credit card statements.  If you do not keep any receipts we would recommend that you begin keeping everything as a first step.

2. Use an electronic spreadsheet so that you can easily change the information over time.  Once this has been set up you have the ability to use the same template year after year and make improvements as you go along.   We recommend setting the spreadsheet up monthly.  By setting the columns up monthly you will be able to identify those months with greater expenses.

3. Every budget should start with your monthly after-tax income.  This is essentially the gross amount that you make less the government’s share.  The net, or after tax amount, is the portion that you have at your disposal to cover costs.   The after-tax income amount is easier for individuals who are employees with set wage amounts.  If you are self employed, earn commissions, or have a variable component to your income, then planning is more difficult.  If you have other income, such as investments, real estate, etc. then this should also be added.

4Once you have several months of receipts in front of you then it should be easier to see your regular spending patterns.  You may want to summarize the expenses into six broad categories such as housing, food, transportation, entertainment, personal, and other to start.  Within these six main categories you could have subcategories – housing (mortgage payments, rent payments, property taxes, utilities, home insurance, repairs and maintenance); food (groceries, restaurants); transportation (gasoline and oil, repairs and maintenance, parking, insurance); entertainment (hobbies, vacations); personal (medical, clothing, fitness, club dues); other (insurance premiums, donations, gifts, child care).

Part of the above process may reveal spending habits that can be improved.  If times get difficult, you should know the minimum amount needed to cover your basic needs.  People who are mortgage/debt free certainly have less stress during difficult times then those who have a lot of debt, especially if interest rates could be potentially rising.  The greater your level of debt, the more you should understand your cash flows.

Rainy Day Fund

A rainy day fund is a pool of money that you can access, without penalty, if you have an emergency.  Having an emergency fund can significantly reduce financial stress.

Once you have calculated your average basic expenses above, you should multiply this amount by three.  This is the minimum amount you should have in your emergency reserve.  Multiplying your monthly basic needs by six will give you even more peace of mind in case of an emergency.

A government worker with a stable job may be fine with a three month rainy day fund.  It is especially important for those in professions with fluctuating incomes (seasonal, commissions) to establish a greater rainy day fund.  A rule of thumb is that the greater your earnings can fluctuate, the more you should have in your “rainy day” fund.  Stated another way, when your income is good, it is time to put a little extra aside in the event you come across days when times are not so good.

Tax Free Savings Account

A TFSA may be one option for some as an emergency reserve.  If the TFSA is used for this purpose then it should be funded accordingly and invested for liquidity and safety.