Life is unpredictable, which is why a rainy day fund is one of the most important components of a sound financial foundation. Even the most prepared, organized people can be caught off guard and put into a difficult financial situation when the unexpected arises. Because of this, itâ€™s essential to have money tucked away in an emergency fund and a rainy day fund. While most people would agree that having easy-to-access cash is important, 29% of households have less than $1,000 in savings, according to a recent MagnifyMoney study.
In this post, weâ€™ll explain exactly what a rainy day fund is, how much you should save and how to start one today.
|Rainy day fund
|Money set aside for predictable expenses, like a roof repair or trip to the mechanic.
|Money set aside for unpredictable, and unplanned for expenses such as job loss, divorce or a sudden change in income.
Often, the terms rainy day fund and emergency fund are used interchangeably. While they are both savings accounts that can be used to pay for the unexpected, they differ in a few key areas. Itâ€™s important to learn the difference between the two types of savings accounts and contribute to both.
A rainy day fund is a designated amount of money that has been set aside for one-off expenses that you can typically predict the need to pay for at some point. Rainy day funds should be easily accessible and used to cover expenses that fall outside of your normal budget. This fund can be used to pay for things like car or house repairs, broken appliances, additional taxes, childrenâ€™s field-trip fees, or last-minute travel expenses. While these expenses are usually not part of your monthly budget, you could likely anticipate the need to pay for them once or twice a year. So, a rainy day fund comes in handy.
â€śThe number one reason to have a rainy day fund is peace of mind,â€ť said Corbin T. Green a financial advisor in Salt Lake City. â€śPeople are able to go to bed knowing that if something were to happen, there are funds available to take care of that.â€ť
This fund allows you to pay for smaller, one-off expenses without going into debt or pulling from your checking account and throwing off your well-planned budget that is used to pay for predictable monthly bills and expenses.
An emergency fund is exactly what it sounds likeâ€”a reserve of money or savings account that you can quickly access in case of an unexpected and unplanned life emergency. Typically, emergency funds are used to pay for unexpected, longer-term events such as medical bills, job loss or divorce.
â€śIf something were to happen where you got laid off, left a job or got injured, having an emergency fund protects you and buys some time,â€ť Green said.
Experts suggest having three to six monthsâ€™ worth of money in this account that you could easily access and use to run your household and pay your monthly bills in the case of an emergency.
It can seem daunting to put extra money away each month, but saving money is a key part of smart financial planning. We know itâ€™s important to save for your rainy day fund, but how do you get started? Here are some easy ways to save more money each month:
Now that youâ€™ve built up some money for your rainy day fund, where should you keep that money? You want to find a safe place to store your money that gives you easy access to the funds in a pinch but can also allow you to earn interest on your funds.
Saving accounts: A savings account is a no-brainer when youâ€™re looking for a place to stash your rainy day fund. Savings accounts are FDIC insured and offer better interest rates than checking accounts. Check out the best savings accounts here.
Money markets: Money markets are a type of account that usually offer higher interest rates than checking or savings accounts. You can access more money relatively easy, but money market accounts may limit the number of withdrawals each month. Also, most money market accounts require a minimum balance to be met.
Checking accounts. Checking accounts probably arenâ€™t the best option for your rainy day fund. They give you quick, easy access to your money, but often offer low, if any, interest. You may also be more tempted to spend the cash if itâ€™s readily accessible in your checking account and youâ€™ve got a linked debit card you can use.
CDs. CDs often charge early withdrawal penalties when you try to cash them out before your term is up. Since emergencies are unpredictable, avoid locking your rainy day fund up in a CD. Stick to accounts that offer easy access like a savings account.
Rainy day funds are usually not used to cover ongoing, long-term, emergency events. â€śIf itâ€™s a true emergency, itâ€™s usually not a materialistic expense,â€ť said Green.
Rainy day funds can be spent on things like car repairs, new tires, and emissions and inspections. Or perhaps you need a new washing machine, fridge, roof or floor? Rainy day funds are meant for such expenses. Most people wouldnâ€™t budget for a new roof because itâ€™s a one-off expense. However, itâ€™s somewhat predictable that youâ€™ll have to repair your car or home at some point, so this type of fund is the perfect financial resource for occasions like this.
However, if you lose your job, become sick or are unable to work for a sustained period of time, you would not use your rainy day fund, but instead, pull from your emergency fund.
â€śUse your emergency fund when something impacts your ability to earn a paycheck or you lose your income and need to use it [emergency fund] to pay your bills and live off of it,â€ť Green said.
Change is the only predictable thing in life. Itâ€™s almost inevitable that something unplanned will occur requiring additional money to pay for it. Knowing this, itâ€™s smart to plan ahead and prepare for the unexpected. Having a rainy day fund is important because it gives you peace of mind and financial protection in case something happens. This type of fund is extra padding in your budget that can keep you out of debt and on track financially, no matter what unexpected life event unfolds.