- Personal Finance
Building An Emergency Fund
Unexpected (Financial) Storms of Life
What are Rainy Day or Emergency Funds?
Rainy day funds are also known as emergency funds. These funds are normally saved in cash accounts with your local bank.
We keep these funds in cash accounts with the knowledge that the funds need to be available in the event of either an unforeseen expense, or unexpected loss of income. Availability of the funds needs to be between one and three days in most cases. This is why we habitually keep these types of funds in a bank.
You could also stash your cash at home somewhere, but there is the risk of theft or loss due to fire. It also does not collect any interest and grow while it is stored at your home.
Cash is normally defined as your money that is readily available at a moment's notice. Some people consider investments in stock accounts as cash as they can sell the stock and receive the proceeds in under 3 days in most cases.
Types of Bank Accounts
Keeping in line with the idea of saving your money with the bank, there are two types of accounts that you may want to consider.
The first is the regular, or standard, savings account. These accounts can be opened with as little as between $10 - $100 dollars. These types of accounts are reliable and offer a small interest payment in return.
The second type of account is called a Money Market Account. This account is actually a checking account that pays you higher interest than the normal savings does. The reason for this is twofold.
First, you need a higher opening deposit and you are normally required to keep a minimum balance throughout the month to prevent getting charged a fee.
Second, the reason these accounts pay higher interest is that the bank uses your money to invest in treasuries and other short term securities. The Money Market Account is similar to a checking account because you can actually write checks against the funds. Normally the check writing privileges are limited. You will need to find out from your local bank what your options are, and what the minimum deposit and type of activities allowed are for each option.
Should You Take It To The Bank?
How Much Do I Need To Save?
Now that you have an idea of where to store your rainy day or emergency funds, the next question is how much do you need to have in that fund?
To answer this question we need to review a few items. First let us discuss the real reasons WHY you would need this type of savings. The top two reasons are unplanned, high dollar expenses and unplanned loss of income.
The first reason is most likely one that all of us have faced. Did you ever have the transmission, fuel pump, or water pump go out on your car? Did you ever have to pay for a tow truck to take your dead car to a garage?
Let us use the example of your fuel pump needing replacement. So you were out and about one day and your car decides not to start when it is time to go home. You call for a tow to a local garage. That is normally around $75 in my neck of the woods.
The next day you find out that your fuel pump needs replacement. For my 1999 Jeep, this part online would cost about $90 - $150. Well we know that the garage is not going to charge me that internet price. Oh by the way, did I mention that my electronic fuel pump is located in the gas tank? That means they have to remove the gas tank to replace the part. Image how many hundreds of dollars more that would cost me!
I am certain that most readers can relate to that previous example. What about your home's hot water heater or air conditioning unit? To get the air conditioning guy to pull into our driveway and say hello cost about $125.
I think you may get the picture.
How Many Months of Savings is Good Enough?
What Do You Think Is a Realistic Goal?
Some Easy Math
$ Per Month Saved
Total After 3 Months
Total After 6 Months
Total After 12 Month
The Second Top Reason to Save
The second top reason for needing this type of savings account is unexpected job loss.
Hundreds of thousands lost their jobs during the 2008-2011 "Great Recession". Many are still losing their jobs today. Prior to this economic downturn the rule of thumb was to have at least three months of living expenses saved. What are your living expenses? Here are a few:
2. Utility bills (electric, water, natural gas)
3. Telephone / cell phone bill
5. Insurance (auto/renters/medical etc)
6. Gas and Car expenses
7. Cable / Satellite TV
8. Membership fees
The idea is for you to add up three months worth of these outgoing payments. You would then use that total amount as your GOAL. Let us say that you are extremely frugal and your one month living expenses does not exceed $1,000. Your GOAL would be to save $3,000.
Sounds like a lot of money doesn't it? If the total amount scares you, then try setting a smaller goal of one month's worth of expenses. If you aim for $1,000 and open the regular savings account with the minimum required of $100, then you only have $900 left to go to meet this goal.
After you have reached this goal, you can aim for the next $1,000 to give you two month's worth of expenses saved. As I mentioned before the three month goal was commonly accepted as normal practice before the "Great Recession". Financial Professionals are now recommending we set aside six to twelve months. Do not let this thought overwhelm you. I would recommend you focus on the achievable three month goal first.
Do Not Store Cash at Home!
Where Do I get The Money to Save?
This next paragraph will discuss how to fund your savings account. We know that you need to open the account with the initial minimum required, what are you going to do after that?
You can choose the tried and true method of manually depositing money each pay day. If you have direct deposit from your employer you have a couple other options. First you can check your payroll settings to see if they allow you to direct deposit parts of your payroll to more than one account. In this case you could tell them to deposit the first $25 or $50 of your paycheck to the new savings fund and deposit the remaining payroll into your primary checking account. This is one of those really beneficial set it and forget it options. I use this one myself.
If your payroll is limited to only depositing to your primary checking account, then you will need to manually transfer the savings fund deposit to the savings account. If you have access to your bank accounts online, then you have the option to set up the transfer and possibly even make that transfer a re-occurring task. When you use the options available through direct deposit you will need to specify and exact amount. You can also change that amount later on if you want to.
Emergency Savings Online Calculator
Bankrate.com provides a FREE college savings calculator and other education calculators to help consumers save for future events.
Managing Your Savings
I used the example above of depositing $25 or $50 per paycheck. You will need to determine how much you can spare from each paycheck for this emergency fund.
You can always increase or decrease the amount if needed. You have control over that. I would also like to mention that there is another guideline for income budgeting which follows this rule:
Using 100% of your earned income AFTER taxes split up the following ways:
10% deposit into an employer sponsored retirement account / or Individual Retirement Account (IRA).
10% deposit into an emergency or other savings account.
10% donate to church or charity.
70% living expenses.
Remember, you can always accelerate your plan by depositing extra money left over in your monthly budget. You can also earn extra money by working overtime hours or a part time job until you reach your goals. If you receive a federal or state income tax return, you can always earmark all or a portion of that income for additional deposit.
If you feel you need more help, you can always search for Personal FInance for Dummies Books on ebay.