Rainy Day Fund Guide
Before we begin setting aside money for retirement, investing, or saving up to buy a house, the first step in everyone’s path to financial independence needs to be building up an emergency fund. The purpose of a rainy day fund is essentially as it sounds; sooner or later it’s going to rain, and you want to make sure you don’t get soaked when it does.
What is a Rainy Day Fund?
A rainy day fund is money that you set aside to be used in case of emergency. Despite our best hopes, emergencies are bound to happen. Your car breaks down, a parent gets sick, a global pandemic and subsequent layoffs happen.
A rainy day fund is money which you can live off of in case of emergency. It should be separate from any investments which you hold, and be readily accessible. For example, your emergency fund should not be in CDs which you may not be able to sell at a moment’s notice. Cash or money in a money market account is a good holding mechanism for your emergency fund.
How to Start Saving
Emergency funds are meant to cover all of your expenses over a set time period. If you are just starting to develop savings and an emergency fund, start by trying to save up enough money to cover 3 months of expenses. From there you can expand to 6 months of expenses, then 9 months. Different people have different ideas about how long an emergency fund should be able to last you, but 9 months is a good rule of thumb and the amount I always make sure I have saved and accessible.
Obviously this is not immediately possible for everyone. If possible, try cutting out some nonessential expenses for a few months to help boost your savings amount. Over time, you should be able to expand your rainy day fund to last several months.
For this process to work, you will need to know what your monthly expenses are, as well as your after tax take-home pay. We have a helpful monthly budget template embedded in this article(insert link here), which also explains how to go about creating a monthly budget.
Once you have inputted all of your expenses as well as your monthly income into the budget template, adjust the “savings” row so that expenses + income is zeroed out. If you are not able to fit all of your expenses in while having any amount left in “savings”, then you are spending more or an equal amount to what you bring in each month. You will need to either reduce spending or increase your income in order to build up an emergency fund.
If, however, you have any amount listed under “savings”, you should be able to use this to calculate how long it will take to build up a rainy day fund. Take your money expenses, and divide this number by your monthly savings. That will tell you how many months it will take to build up a month’s worth of emergency funding. You should then be able to multiply this number by 3, 6, or 9 respectively to determine how many months it will take to develop a 3-month, 6-month, or 9-month emergency fund.
Don’t Be Afraid to Use It!
It’s common for people to be worried about deploying their rainy day fund once hard times actually hit. In fact, some people lean on credit card debt before using their emergency fund. I cannot stress this enough, DO NOT DO THIS.
Your emergency fund is there to get you through hard times. Credit card debt is incredibly expensive, as credit cards have some of the highest interest rates available. Leaning on money available through credit cards will still be an option once your emergency fund is gone, but using your saved rainy day fund which has been set aside for this purpose is much more efficient than taking out new debt, especially high interest debt like that offered by credit cards.
If you have the opposite problem and your emergency fund is getting too large, consider investing some of it into stocks or bonds. Just remember to keep enough to cover 9 months of potential expenses.
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