How to build an impossible emergency fund

If your income fluctuates month-to-month—or perhaps your expenses do—then you definitely need to read this.

For Liz-Anne Tam, summer is her busiest time of the year. The 25-year-old Torontonian runs her own plush toy business, Tenta.co!, and she makes the bulk of her income between May and September, travelling to different cities each week to sell her tentacled creations. If you’ve attended an anime convention or night market recently, you may have seen people wearing one of her stuffed octopus headbands: the grilled and battered Pon, the grumpy half-skewered Red or one of a pair of ice cream cone–sporting cephalopods, Melty and Momo. They range in price from $12 to $50.

“When I started doing my own octopus plush toy thing, it made me realize I could earn more money on my own than I could working for someone else,” says Tam, who has been earning a living through a series of side hustles for several years now. While Tenta.co! remains her main source of income, Tam earns extra cash selling other items online and picking up shifts at a local antique store. In the fall, it all winds down when she goes back to school. In contrast to her high earnings during the summer, Tam will need to survive on the income she generates from online sales of her plush toys.

She’s one of millions of Canadians who support themselves without a steady paycheque. One study released in May from Toronto-Dominion Bank shows that more than a third (37%) of Canadians experience moderate to high income volatility, meaning they don’t count on a steady paycheque. Of those people, part-timers, self-employed and millennials are some of the groups most likely to experience income that fluctuates month-to-month. Certified financial planner and millennial finance expert Shannon Lee Simmons calls this “the new norm.” She runs a fee-only financial planning firm called The New School of Finance. One of her specialties? Helping millennials who don’t rely on a steady paycheque to learn that while their income may vary, the state of their finances doesn’t have to.

The key to survival, says Simmons, is to have a healthy cash cushion. Like many personal finance experts, she recommends having enough money in reserve to cover about five months of expenses. Do you know how much you would need? Put it this way: If you regularly spend $3,000 a month, you should aim to have $15,000 put aside in an emergency fund. Sounds like a lot, right? Don’t panic. A big number like that probably seems impossible, but Simmons lays out five things you can do to get there.

1. Start small

Simmons says that an emergency fund should be something that you work towards as a goal, not something you wake up with one day. Which is good, because when the Canadian Payroll Association surveyed 5,600 working Canadians in 2016, it found that 48% of us are living paycheque-to-paycheque. A quarter of respondents admitted they wouldn’t be able to come up with $2,000 in an emergency. When starting out, Simmons suggests focusing on the habit of saving, not the amount. You just need to take that first step: “Don’t underestimate the importance of small amounts, like fifty dollars a month,” she says.

Do this now: Put $50 (or whatever you can afford) into a separate savings account right now. Every time you get a cheque, make a habit of putting a some portion of it into that account. There. You have a cash cushion. It’s just really small.

2. Find your magic number

Your magic number is how much you need to spend to get by every month. Here’s a question: What do you do when you’ve had a good month and you’re raking in the dolla-dolla bills? Do you treat yourself? While that might feel great, you need to make sure your future self is sharing in the wealth too. Rather than let your paycheque govern your spending, figure out how much you need to cover necessities like rent, utilities and food. Add a little extra for real life and make that the number you live by. When a fat cheque does roll in, resist the temptation to blow your earnings. You may rely on them during leaner months.

Do this now: Add up your monthly expenses to see how much money you realistically need to get by. (You can break it down weekly if that’s easier.) Write that number down. This is your spending limit. Make an effort to stick to it, even when you’re feeling rich.

3. Set a goal

Wait, isn’t your goal just five times your magic number? Technically yes, but while goals give us a target to work toward, huge ones can feel overwhelming. It’s better to break it up into chunks. Psychologists refer to this as Goal Gradient Effect: We tend to work harder towards goals when we can see real progress. Think of it like going to the gym. “If you’re working out, you don’t go right into the heavy weights, you start small and you build,” Simmons says. Instead of setting a goal to save $15,000, your goal might be to first save $500. Once you get there, see if you can afford to put away just a little bit more each paycheque.

Do this now: Remember that $50 you stuck into a new account? Can you do it ten times in a row? Hit that streak and you’ll have $500, enough to replace your smartphone if it dies.

4. Save in percentage not dollar amounts

It’s great to start off with saving by putting something (anything!) away. But Simmons says that in the long run it will become hard to consistently save a certain amount of money if you’re making several hundred dollars one month and several thousand the next. Simmons strongly suggests aiming to save a percentage of your income instead of a dollar amount. This will give you more flexibility and mean that you’re saving more in your good months and less during lean ones.

Do this now: Make a goal to set aside 10% of every cheque you receive. (One popular tactic is to put 5% towards long-term savings and 5% to your short-term emergency fund.) If your income averages out to about $3,500 a month, you’d be saving $350 a month for your future self.

5. Don’t forget the taxes

If you’re self-employed, this is the advice you never want to hear but totally need: “The number one place where self-employed people end up ruining their finances is that they don’t save enough for tax time and then they can’t escape the taxman,” Simmons says. She advises talking to someone about your taxes to get advice on how much you might owe around tax time. Once you have an idea of your tax rate, you can get an idea of what percentage of your income you’ll need to set aside for taxes. It’s better to over-save now than raid your new cash cushion when you find out you’re short.

Do this now: Talk to someone to get a sense of how much you’ll need to save. Make a point of transferring that money with each paycheque.

What experiences have you had working with an unsteady paycheque and what tips do you have to share? We would love to hear your stories. Let us know in the comments.