We have insurance for almost every aspect of our life: car, home, life, travelers, etc. What about insurance for life's uncategorized and unexpected events? A rainy day fund protects you from such events in the same fashion car insurance protects you against theft and damage. A rainy day fund is money that you set aside for the specific purpose of dealing with the inevitable—but unforeseeable—events of life that would otherwise put you in a financial pinch or disaster. Follow this expert advice to begin building your rainy day fund, and avoid the undue financial stress that emergencies so often cause.
- set aside money for a rainy day
- treat it like insurance
- use a separate account
- make monthly allocations
- define what an emergency is
- use credit
- stop contributing
- treat it like an investment
- increase your deductibles
- use for non-emergencies
The first step to having a rainy day fund is setting aside money for the fund. Setting aside $500 to $1,000 is a great start and it should be your goal to keep at least this much in your rainy day fund. This way when an unexpected expense comes up, all you have to do is use the money from your rainy day fund.
The rainy day fund is essentially insurance. Just as your insurance company collects your premiums and pools them together to pay any potential damages down the road, you contribute money to your rainy day fund to help pay for those uninsured damages down the road. The only difference between you and the insurance company is that you are completely responsible for your own rainy day fund.
A rainy day fund must be a separate cash account. The best kinds of bank accounts to use are savings accounts and money market accounts. If you already have a savings or money market account, open a new one just for the rainy day fund. The only money that should be in the rainy day fund account is money for the rainy day fund. You should have a debit card or checks to this account, so you can quickly access the money when needed.
To reach your initial goal of $500 to $1000 for your rainy day fund you should decide on how much you can afford to contribute each month. When you are first starting out you want to contribute as much as possible until you reach your initial goal. Once the initial goal has been reached, continue to make comfortable monthly allocations to continue its growth.
When you purchase insurance you know exactly what the insurance is for. Car insurance covers your car. Homeowners covers your home. Rainy day fund covers _____? This is a question that you have to answer before emergencies happen. A good place to start is to consider your current insurance level and coverage. If you were to have a year of really bad luck, what could be damaged, lost, broken, or stolen that your current insurance wouldn’t cover? Determine what areas your rainy day fund should cover, and stick to it.
By definition, a rainy day fund is a cash account. It is not a special credit card or line of credit. When you use credit to cover an emergency, all you are doing is trading one expense for another. Using credit is the equivalent of procrastinating. Not only will you have to pay the amount in the future, the amount you ultimately wind up paying is significantly more due to interest charges than it would have been if you’d dealt with the emergency up front.
Having an initial goal for your rainy day fund is good, but that’s not the end of it. Just as you pay insurance premiums each month, you should be contributing to your rainy day fund each month. Once you have met that first goal of $500 to $1,000 as mentioned above, budget a monthly amount, between $25 and $75 each month to contribute to your fund. This contribution should be perpetual until your fund has grown to 3 to 6 months of living expenses.
Your rainy day fund should not be considered an investment or actually be an investment; it’s cash insurance that you need to have complete control over. The sole purpose is to have money set aside to deal with life's unforeseen challenges. In the same way, investments represent money set aside for the future. However, unlike the rainy day fund, investments are not designed to be liquidated at a moment’s notice. Many brokerages will charge fees for liquidating quickly and it can take days for the money to transfer into your bank account. A rainy day fund must be comprised of money that is immediately accessible.
The rainy day fund is designed to compliment your other insurance policies. It’s to fill in the gaps that your car, home, renters, life, travelers, etc. might not cover. It’s not designed to completely replace all of those. If your emergency fund grows so large that it equates to 6 to 12 months of living expenses, only then should you consider lowering your insurance deductibles. The money you would save as a result of increasing your deductible is miniscule compared to the added risk you take on by doing so.
What exactly is a financial emergency? Is it when you see a new pair of shoes you just have to have? Is it when it’s time to take the kids back-to-school shopping? Or those annual club membership dues that you always forget about? In most cases the answer would be “no.” Emergencies are events you can’t possibly plan ahead for. School starts the same time each year, as do those membership dues. These events aren’t emergencies because you can plan ahead for them. Finding water damage? Someone hitting your car while you're shopping? These are instances that you can’t see coming. You must only use your rainy day fund when an actual emergency occurs. Otherwise, you may leave the store with your new pair of nice shoes only to find a new dent in your car.
A rainy day fund covers life's inevitable surprises. The more diligent you are in contributing to your fund, the more effective the strategy will be. The rainy day money should always be kept in a separate account, that is easily accessible, and with clear rules on when to access them. Having a rainy day fund won’t stop the rain from coming, but it can turn what would have been a storm into a light drizzle.