Saving for the unexpected is a sound financial practice that can save you many headaches in the future. Whether your car breaks down or you have to fly across the country to attend an unexpected family event, these costs can hurt you if you’re not prepared. Both an emergency fund and a rainy day fund can be good tools to help you prepare for the unexpected and ensure you don’t have to put these expenses on a credit card or take out a personal loan.
Emergency funds and rainy day funds are helpful tools that can help you save for the unexpected, but they have some differences. It’s important to understand how each works and what each is used for before deciding whether you need one or both to properly prepare your finances.
What Is an Emergency Fund?
An emergency fund is where you save money to pay for unexpected emergencies. An emergency fund is used when a big life event could have a negative financial impact, such as losing your job or coming down with a severe illness.
The emergency fund can cover the added costs of medical bills, or you can use those funds to pay your bills while trying to find more work. An emergency fund typically has substantial money saved up to help pay for these larger expenses.
When to Use an Emergency Fund
An emergency fund can be a good idea for everyone, because no one is immune to significant life events that come out of nowhere. When the economy turns south, for example, very few jobs are entirely protected and safe. This fund serves as a financial tool that can give you a safety net for these life events that are completely out of your control but could create financial havoc.
It’s recommended that consumers work to build an emergency fund in their budget, unless they’re currently able to survive for 6 – 12 months without their income from money in their bank account. Additionally, you can create an emergency fund and keep your money in a high-yield savings or investment account to earn more than you would if it were just sitting in your regular checking account.
So What Is a Rainy Day Fund?
A rainy day fund is also used to pay for unexpected expenses, but it typically covers lower-cost items like an unexpected doctor’s visit or fixing a broken appliance. A rainy day fund can be a great way to give yourself peace of mind and avoid unnecessary debt for everyday routine things. A good goal for a rainy day fund would be $1,000, and typically no more than a few thousand dollars at any given time, which can be used as a safety net for your monthly budget. However, this total can greatly increase depending on where you live or how many children you have.
When to Use a Rainy Day Fund
Rainy day funds are typically for individuals or families who live paycheck to paycheck and can’t afford much wiggle room in their weekly or monthly budget. Some things that a rainy day fund is generally used for include fixing a broken vehicle, paying for an emergency room visit, or a flight to attend an unexpected funeral. These expenses could throw your budget off course, but typically can be paid for with a bit of sacrifice.
It’s better to pay for each smaller expense out of your rainy day fund than to put them on a credit card and pay interest. Consumer spending has continued to climb throughout 2022, and much of it is being used for everyday expenses that just didn’t fit into people’s budgets. Using a credit card forces you to pay more for your expense than it really costs, and it requires you to make a monthly payment on what you now owe the credit card company.
How Much to Save: Emergency Fund vs. Rainy Day Fund
One of the largest differences between these two types of financial tools is how much you need to save in each account. The amounts will be pretty different because you’re saving for different expenses in each account. The rainy day fund will pay for expenses typically under $1,000 each time, while the emergency fund could cover the cost of all your bills for 6 months.
The amount of money you save on each will vary by a number of different things. Here are a few things to consider before deciding on how much to save:
Children: The number of children you have, and people in your household, can increase the amount you need to save in each account. For example, children are more prone to go to the emergency room for an accident. Each additional person in your home also requires more money for utilities and food every month.
Location: Where you live is one of the most important things to consider. Planning for expenses in New York differs from paying your bills for six months in North Dakota. Your cost of living and job prospects in your area will greatly affect how much you save.
Your Job: What you do for a living and how much you make should impact how much you can save. If you have a very niche job without a lot of prospects then it will likely take you a long time to find work if you lose your job. Also, the more you make, the more you may need to save to maintain a sense of your current lifestyle with your home and food expenses.
Your Possessions: The car you drive and the high-tech appliances you own play a large role as well. If you have things that are expensive to maintain or fix when broken, then you should increase how much you’re saving.
You can consider saving 3% of your monthly income into your rainy day fund. So, if you make $6,000 per month, you would put $180 away into this fund until you feel comfortable with the amount of money you have saved.
For an emergency fund, you’ll want to save enough so that you have six months of your total living expenses, or more, saved in your account. For example, if your monthly living expenses are $3,500 then you’ll want to work to keep adding to your emergency fund until you’ve saved $21,000 or more. The amount you save each month will depend on your budget but should be as much as possible until you hit the right total.
The total amount of money you save in either account will depend on the above factors, but it should give you peace that you have the money when something goes wrong.
Where to Keep Your Savings
Your rainy day fund can be kept in a number of different assets, as long as you have easy access to withdraw money when needed. The most important thing is to ensure that your money is protected in an NCUA-insured account so that you know it is safe. Here are some examples of where to keep your savings:
Checking Account: Some people prefer to keep their funds in a separate checking account because they always dip into it to pay for expenses. This will earn less than other options, though.
Savings Account: This is probably the most popular option because it gives you both accessibility while potentially earning a decent amount (like with a high yield savings account) on the money you’ve saved.
Investment Account: If you want to maximize the earnings on your money, and you don’t think you’ll dip into it very often, then opening an investment account might be the way to go. This is the riskiest option, though, and isn’t recommended for those that have frequent unexpected withdrawals.
The Bottom Line
Most people can’t afford to have their finances caught off guard by an unexpected ER trip, a family member passing, or a work loss. While these burdens are never easy, they can become manageable by taking steps to prepare for them. One of the best things anyone can do is to prepare financially by saving for these expenses through a rainy day fund and/or an emergency fund. Saving both prepares you for the full realm of unexpected possibilities.