Saving for a Rainy Day
Photo by Ravi Kant at Pexels
There's no better time than now to start saving - here are some tips on filling up your rainy day fund.
Are you able to afford a $1,000 emergency expense?
If so, you're among only about 43% of Americans who can cover a $1,000 emergency expense, according to a recent study published by Fidelity (link opens in new tab).
Another study (link opens in new tab) says that more than one in five Americans have no emergency savings at all.
As you can imagine, these studies also link a lack of emergency funds to stress and anxiety around finances. The Fidelity study says a lack of emergency savings is a major source of stress, and half of participants say their lack of emergency savings causes them to be distracted at work.
Rainy Day Fund or Emergency Fund: What is it, and why should I care?
Cash in your bank account: some people call this an emergency fund. I don't like the idea of having an "emergency" related to money, so I prefer the term Rainy Day Fund. Rainy days come along, just like sunny days. On a rainy day, you bring an umbrella or wear your waterproof shoes. No big deal, right? Same thing with your money. Having funds readily available for those "rainy days" can really improve your peace of mind.
How much cash should you keep in your bank accounts? And what is it really for? This often comes up with clients, especially since it seems like cash sitting in a bank account is lazy money - shouldn’t all your money be invested and working for you? Maybe not in the way you think! Let's dive in.
What's a Rainy Day Fund used for?
One critical aspect of a holistic financial plan is assessing, and mitigating, financial risk. As an example, you can mitigate the financial risk of a car accident through having insurance coverage. A Rainy Day fund, cash in the bank, can be another way of mitigating risk. The purpose of a Rainy Day fund is protection, not growth.
Your Rainy Day fund can cover things like a nail in your tire; replacing your refrigerator when it stops keeping the cold things cold; the health insurance copay for your son's broken arm; losing a job.
Some solo-preneurs who completely lost their income during the initial months of the Covid-19 pandemic. While they waited for unemployment benefits or small business loans to come through, they were able to continue making ends meet with the use of their Rainy Day fund.
I've worked with clients who lost their job. Even though they received severance from their employer, they needed time to process the surprising events, put together an updated resume and LinkedIn page, and start networking and applications. All these steps can take months. Clients with a Rainy Day fund were still able to pay their bills and have enough cash to carry them through until their new job started.
Younger clients are just starting out and anxious to make the right choices with their paycheck. Even though their monthly expenses are not all that high, a Rainy Day fund comes in handy when they need to come up with a deposit on a new apartment lease, car repair, or unexpected flight home to see an ailing family member.
And, I've helped some families work aggressively to get out of personal debt or student loans. Even for these families, a Rainy Day fund can be critical because as they keep a tight handle on their expenses, and put every extra dollar towards debt paydown, there still may be a month here or there where they overspent. The Rainy Day fund can help pay off that once-in-a-while overspending instead of adding it to the personal debt burden.
Where should I keep my Rainy Day Fund?
This has become a bigger question these days, as banks advertise high yield savings accounts and CDs and money market funds are delivering rates over 4%. However, remember that your Rainy Day cash needs to be accessible for the surprise day when you need it.
If you lock it up in a 6 month CD or put it in a high yield bank account with penalties for low balances, this money isn't actually serving its purpose. The purpose of a Rainy Day fund is protection, not growth. Sure, if you can make a little interest on it, great, but keep the funds liquid and easily accessible so you can get the money when you need it.
How much should I keep in my Rainy Day Fund?
Typically, a rainy day fund should contain enough money to cover 3-6 months of expenses. This depends, of course, on your particular situation - the type of job you have (how stable is it?), how tight or flexible your budget is, how much of your monthly expenses are variable vs fixed, whether you have personal debt, and how much you typically save in a month.
But let's start with your monthly expenses. To figure out how much your monthly expenses are, look at a recent bank statement and tally the expenses you paid. You can also note your monthly income, then note how much (if any) you have "left over" i.e., still in your checking account at the end of the month and after you've paid off credit card bills.
Say your checking account balance at the beginning of the month is $1,000. You received monthly income of $10,000. At the end of the month, and after you paid off your credit card, your checking account balance is $2,000. This suggests in a month, you spent $9,000 ($1,000 + $10,000 = $11,000 - $2,000 = $9,000).
So in this example, this person should have $27,000 in Rainy Day Savings if their goal is 3 months' worth of expenses. ($9,000 x 3 months = $27,000)
How can I build my Rainy Day Fund?
It's ok to start small. It doesn't take much to make some big long-term improvements. With each paycheck, set up an automatic transfer to your Rainy Day savings account. This way, the Rainy Day fund can grow without you needing to think about it.
Next time you receive a "windfall", whether it's a check in your birthday card from your aunt or your annual bonus or raise, immediately allocate this “windfall” money towards Rainy Day. If it’s hard not to spend it, think about how you're helping your future self by allocating this money towards a future Rainy Day instead of spending it on the present day you.
Tips to increase your Rainy Day Fund savings.
Pay yourself first. Set up an automatic transfer from your checking account to your Rainy Day account, each day you are paid. Say you're paid on the 15th and 30th of each month. On those days, set up an automatic transfer of a set amount into your Rainy Day fund.
Get some information about where you're spending your money right now. Create a budget using the method here or another one of your choosing.
Look at options for cutting back monthly fixed expenses. Can you refinance your mortgage, or negotiate with your landlord for a decrease in rent? Can you cut back on monthly subscriptions to news services, or entertainment like streaming music or video services? Are you still paying for the international plan on your cell phone bill?
Intentionally change your spending habits. Think back 5 years, How have your spending habits changed since then? Maybe you’ve added a morning commute Starbucks visit; or spend weekends shopping at a local clothing store on your way to dinner out with friends. Starbucks coffee drinks can easily cost $10. That could be $50 / week, or $200 / month. Being mindful of your spending can build up your Rainy Day savings.
Food spending. Food could be considered discretionary, only because you can choose what you eat. Eating out or ordering take out is usually way more expensive than doing your own cooking. Spend a little time collecting some recipes in a folder that you know your family enjoys that are also simple to prepare (I've been loving this lime chicken and Mexican cole slaw on soft tacos - links open in new tab). Before you head to the grocery store, choose a few recipes you'll make, and make a shopping list. Then only get the items on your shopping list (online ordering can help avoid impulse grocery store purchases). You'll have the opportunity to eat healthier and also save some money. Another idea is meal planning kits like Hello Fresh, which can help to cut back on last minute take out orders since they are so easy and quick.
Make your credit cards less accessible. Put them in the back of your wallet, or keep them at home in a drawer. Put a sticky note on your credit card that says "rainy day" as a reminder to not mindlessly make purchases when you know you're saving for your Rainy Day. This may be a bit more difficult in the digital age when Apple Pay and other digital wallets are so prevalent - does it make sense to remove your cards from your digital wallet temporarily while you’re saving for your Rainy Day?
And don't forget to celebrate your wins. Give yourself a small reward for reaching set goals along the way. The reward could be a pint of that gourmet ice cream, a kitchen gadget you've been eyeing, or a car wash and detail - whatever feels like a special treat for you.
Once you've started this saving process, keep going! When you've built up your Rainy Day fund, consider where else you can keep saving. Are you contributing to your company's 401k or retirement savings program fully? Are you planning a vacation? Start saving now so it's fully funded by the time the trip begins. And congratulations! You're on your way to building healthy money habits.