Eventually, everyone has an unexpected incident that demands unplanned expenses. These emergencies can be from a broken phone to a health issue that turns your life upside down. Regardless, they usually have some level of financial ramifications. Even though you can’t predict this emergency, you can prepare for the moment it comes.
A way to prepare for the potential financial consequences of an unexpected expense is to open an emergency fund or a rainy day fund. As simple as that sounds, there are many types of accounts that can serve for this end. Some of them have specific utilities, while others can be used in a more general matter. This article will help you navigate through these options. On top of that, it will explain everything you need to know about emergency and rainy funds, their differences, and how to save for them.
Both emergency and rainy day funds are intended to be a place where you can have money for unexpected milestones. However, they have a few differences.
Emergency Funds are intended to be your safety net in case you have a financial emergency. These emergencies could be the loss of a job, a major illness or injury, and so on. Thus, emergency funds usually have more money than rainy day funds. The ideal is that you have enough money to face major events that can mess with your finances.
Rainy Day Funds, however, serve as a reserve for one-time smaller unforeseen expenditures. Some examples are repairing your car, paying braces for your child, or other short-term smaller unplanned costs. Basically, a rainy day fund is supposed to cover all those small inconveniences that always pop up. This type of account is great to avoid getting into debt, as these small expenses can ruin your entire budget.
Since they serve slightly different purposes, the amount of money you should have in each of these accounts should also be different.
For Emergency Funds, it is ideal to first know how much you spend per month. Then, subtract the superficial expenses that you can live without and see how much you need to keep going for one month. Once you know that value, try to project it for a few months and there you have it. The idea is that, in case something happens, you have money to keep paying your bills for a while. Some people can only manage to save for 3 months; others can do it for six. What matters is to go towards the goal of having enough in case you have no income for a while. Start with a goal you can achieve and keep growing until it is ideal for you.
There are also some more specific cases, which we will get into later. For example, if your emergency fund's goal is to pay unexpected medical bills, you should take a look at the expenses of the most common illnesses and injuries to have an idea of how much you want to save for that. If you have a predisposition for a specific illness, check its treatment prices. And of course, try to have health insurance to soften the expenses.
Rainy Day Funds can follow this same logic. Make a list of potential unplanned expenses that can happen. Once you have an idea of how much that would be, prepare to have at least a few incidents happening in an unlucky short period. There it is how much you should try to have at your rainy day fund. Most people have around $500 to $2,500 in this type of account, which is a good amount.
If you already have the money in hand to put in these accounts, it won’t be that hard to figure it out. But if that is not the case and you will have to build these savings gradually, there are a few tips to help you.
Set a Goal for Your Funds. If you can’t save much, start with small goals, a few hundred. Then, keep increasing your goal until you feel like you have saved enough for sudden emergencies or expenses. There is no right answer to what is the ideal goal. The important thing is that the goal you set will make you feel safer, more prepared, and relaxed.
Analyze Your Monthly Budget and identify where you can draw from. In case your budget is completely taken, you will have to make choices so you can designate a share of your income to your emergency or rainy day fund. If you already know you will have some large uncommon expenses in a few months, such as a band camp for your child or a baby shower you are responsible to organize for your friend, include that in your budget. Unexpected expenses and only those you don’t have time to prepare for.
Focus on Building the Habit and Consistency of Saving. It can be hard in the beginning, but saving becomes less painful when you start to get used to it. The goal is that saving becomes something natural. Automatic deposits to your emergency or rainy day fund can help a lot with not cheating on the saving commitment. Avoid at all costs waiting to see how much money is left at the end of the month to then put it into your fund. This never works. You will likely pass your budget limit if the money is still in your checking account to be spent.
Knowing When to Stop Saving is when the process changes most for both of these funds. You will probably spend your rainy day fund more often than your emergency fund. Thus, saving for your rainy day fund should become a habit. Unless you are lucky, you will have to refill this account constantly. As if you were paying your unexpected expenses in parcels, but without paying interest like a debt. You can even earn interest in the process since you are doing it before it happens instead of after.
The emergency fund is a little different. First of all, while rainy days are unavoidable and you will have them eventually, larger life-changing emergencies rarely happen. You are prepared if they do, but hopefully, you will rarely have to get into these savings. Also, depending on your income, you may be saving for your emergency fund for a few years. Then, once you reach your amount goal and feel financially ready for emergencies, you don’t need to keep saving for this account. There is no need to save forever for your emergency fund. Once that is built, you can move on to other types of investments. Or maybe start saving for a more pleasant goal such as buying a house or your kid’s college.
As mentioned earlier, there are a few different types of accounts and investment models that can serve as your emergency or/and rainy day fund. Some of them are focused on specific circumstances, while others are more generic. The three characteristics you should look for when choosing where to open your emergency or rainy day fund are:
So here are some suggestions of where to open these funds:
Savings Account - Good for Emergency and Rainy Day Funds
A savings account is a great place to have your savings designated for unplanned financial expenses. Savings accounts have great liquidity, allowing you to withdraw money whenever you need it. On top of that, some high-yielding savings accounts offer good interest rates. The yielding of online savings accounts is especially higher once they don’t have the expenses of physical branches. When choosing a savings account, pay attention to the fees and rules on withdrawing. The more liquid and fewer fees, the better for an emergency or rainy day funds.
Money Market Account - Good for Emergency Funds.
Money market accounts are similar to high-yielding savings accounts, but not the same. This type of account can sometimes come with a debit card and check-writing capabilities, which can make them more convenient. Another major difference is that generally there is a larger minimum deposit to open a money market account. Due to that, this is not the ideal place to open a rainy day fund, which usually has a lower balance than an emergency fund. Many money market accounts also limit the withdrawals per month, so make sure the rules around that fit your needs.
Health Savings Account (HAS) - Good for Emergency and Rainy Day Funds
This option is great for those who wish to save for illness or injury emergencies and have a high deductible health care plan. This type of account offers a triple-tax advantage because:
There is a contribution limit of $3,450 for individuals and $6,900 for families. HAS can be used as a preparation for major unexpected health expenses, or eventual unplanned medical expenses. Thus, it is a good fit for both types of funds this article has been analyzing.
Crypto-Based Savings Services - Good for Emergency and Rainy Day Funds
While cryptocurrency is a little too risky and volatile for your emergency and rainy day savings, other financial services based on cryptos can offer lower risks. The returns are not as high but are still quite competitive if compared to the other options. For example, crypto saving accounts can pay interest rates as high as 12%. However, before jumping into this alternative, make sure the service offers enough liquidity and stability for your money.
Ideally, yes. Having a rainy day fund will keep you away from debt and an emergency fund can save you from a major personal financial crisis. For these reasons, having both is a very wise decision. Some may even say that setting these two funds in place should be a priority that can assist you in saving for other goals such as your dream home or a smart investment.