Rainy Day Fund vs. Emergency Fund – Do You Need Both?
Chances are, you’re familiar with the term emergency fund. If not, here are the basics: Experts suggest keeping at least 3 to 6 months of living expenses in case of an unexpected financial emergency, such as job loss or sudden illness. This account should be relatively liquid. That way, you can access it quickly if you need to.
Rainy day funds may sound similar, but they’re really intended to pay for on-off, smaller expenses. For example, let’s say your refrigerator suddenly stops working and you need to replace it, or your pet needs unexpected surgery. (Though in the latter case, pet insurance might help take the sting out of that expense.)
We outline the differences between an emergency fund and a rainy day fund, what each should be used for, and the best strategies for setting them up.
An emergency fund is intended to be your safety net in the event of a financial emergency. These emergencies include, but aren’t limited to, job loss, or a major illness or injury.
You should aim for an emergency fund of at least 3 to 6 months of living expenses, including all bills, debt payments, and everyday spending, such as grocery bills, childcare costs, and transportation costs. But if you are a single-income family, have a serious medical condition, own a home, are self-employed, or are trying to stay out of debt, an emergency fund becomes an even more pivotal piece of your financial plan.
Rainy Day Fund
A rainy day fund is intended to pay for a one-time, smaller expenditure. For example, paying for summer camp or braces for your child, or replacing a broken window in your home – any other short-term, unexpected cost.
A rainy day fund helps you avoid going into debt by covering all those small inconveniences that always seem to pop up. While a $250 repair to your car may not seem like much, it can throw your entire budget out of whack or even put you into debt if you aren’t prepared.
Setting Up Your Funds
To set up your emergency fund, you first need to decide how much you’d like to have in your fund. For some, three months’ living expenses is the most they can swing. Others may be able to set aside 6 months. Remember, the most important thing is that you have at least something in your emergency fund. Then, you can work toward your goal over time. The same principle applies to your rainy day fund. Figure out how much money you’d like to have in your fund, then work backward from there.
Let’s start with your emergency fund. Divide the amount you’ll need to adequately fund your account by how much you can afford to put aside each month. Then, you’ll be left with the number of months it will take you to reach your goal.
For example, let’s say your monthly expenses are about $3,000, and you want to set up a 3-month emergency fund. That means you’ll need to save around $9,000. If you set aside $500/month, you’ll fully fund your emergency fund in about 18 months. While this may sound like a long time, don’t forget about unexpected windfalls like tax returns, cash gifts, or even monetary inheritances. You can use some of this to pad your emergency fund and help cut down the time it takes to fully fund it.
Next, you’ll need to decide how much you need for your rainy day fund. In this case, thinking longterm about some of your expected expenditures will help you decide how much you need. Do you have an aging pet? Do you kids need braces? Do you live in an area where hurricanes or tornados are common? Is your air conditioner on the fritz? Factor all these into your decision.
Then, like your emergency fund, divide the full amount by how much you can spare each month. So, if you want a $2,000 rainy day fund and can afford to set aside $75/month, it will take you just shy of 27 months to reach your goal. You could also make other small cuts your budget or even collect spare change to help fund your rainy day savings.
Finally, you’ll need to factor both these expenses into your budget. And add a line item for funds to allocate to each account, and set up automatic debits each month so you don’t fall behind on your goals.
You should keep your emergency and rainy day funds relatively liquid. This means you can access it easily and without paying a penalty. A high-yield bank account or a money market account are two good options. You could also keep your emergency fund in a traditional savings account.
While saving for an unknown emergency or “rainy day” may not seem like the most exciting way to allocate your hard-earned cash, in the face of a true financial emergency or an unexpected bill, you’ll be happy you did.