Why should you have a rainy day fund?
Everyone should have a rainy day fund. Why? Because it gives you a safety net if something unexpected happens and you need money fast.
The point of a rainy day fund is to cover surprise expenses you weren’t planning for. For example, your car breaks down or you have a medical emergency or you lose your job.
In all of these cases, you don’t want to be scrambling to find funds. You also don’t want to be forced to divert funds from your other goals.
Diverting funds from your other goals is detrimental for a couple reasons. First, it slows down your progress toward those goals. All of a sudden, you will find yourself off course for the life milestones you want to hit.
Second, you might actually be moving yourself backwards without realizing it. If you try to withdraw from certain accounts, you might actually lose money.
There are some accounts that incur taxes or penalties if you withdraw your money before a certain time or if you use the money for a purpose other than that designated by the account.
Retirement, health savings and investment accounts are all examples of this. If you withdrew money from these account types to pay for an emergency situation, you would likely incur a penalty.
Therefore, it is important to have a specific account with savings designated for an emergency. In other words, a rainy day fund.
Now that we’ve established the importance of having a rainy day fund, the next question is how much money should be in that fund?
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How to set a savings target for your rainy day fund
If the point of a rainy day fund is to cover unexpected expenses, you won’t know how much money you need until one of those unexpected situations happens. So how do you set a savings target?
A good place to start is with the biggest possible emergency expense that could come your way.
For a lot of people, this would be losing your job and thus your income stream, meaning you have to live off your savings until you can find a new job.
In a worst case scenario, let’s say it takes you six to nine months to find a new job. You will have to cover your living expenses for that period of time.
If you’ve lost your income stream, then that money will be coming out of your savings. This is where your rainy day fund would come in.
Calculating your goal
Calculate how much money you would need to cover, at a minimum, your essential expenses each month. Essential expenses are the things that you need to operate on a daily basis like your rent or mortgage payments, food, clothes and transportation.
Next, multiply that monthly number by at least six to determine the total amount you need saved to live off of for six months without income.
That number becomes your savings target for your rainy day fund.
The cost of six months of living expenses is likely a large number. That is why it is a good goal to set for your rainy day fund.
Even if you (hopefully) do not face a job loss, that amount of saving will likely be enough to cover other large expenses that may come your way like a medical emergency or a car repair.
Of course we hope that you won’t have to dip into this fund but you can rest a little easier knowing that you have a plan in place for the unexpected.
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