When you outline a saving strategy, you’re likely focused on exciting opportunities: amassing enough money for a down payment on a house, buying a new car or taking a vacation. However, building up your reserves isn’t solely about looking forward to the sunny side of life. It’s equally important to keep a stash of cash for when trouble arrives. That money is known as a rainy day fund.
What is a rainy day fund?
Rainy day fund definition
You may be familiar with the need for an emergency fund, but a rainy day fund is different. The fund is meant as a safeguard for shorter-term and lower-cost struggles, like home maintenance or parking tickets.
“The major difference between an emergency fund and a rainy day fund is the size and scope of each,” says Daniel Mong, CFP, financial advisor at Maryland-based Greenspring Advisors. “An emergency fund is reserved for life’s truly unexpected events such as a divorce, job loss, or really any event that was unexpected and has severe consequences on finances. A rainy day fund is reserved for life’s smaller, yet expected expenses.”
What costs should you use a rainy day fund to cover?
What are those expected expenses? Consider all the small issues — like needing to buy new tires for your car or fixing your furnace — that could force you to open your wallet on a less-than-perfect day. Use your rainy day fund to cover these kinds of costs.
“This account does not need to be nearly as large as an emergency fund,” says Michael Kelly, CFA, CFP, equity analyst and financial advisor at Massachusetts-based investment firm Beck Bode. “This account is expected to be drawn on at some point and then replenished as needed. Typically, the recommendation is on about $500 to $2,000, depending on people’s circumstances.”
What’s the right amount to put in a rainy day fund?
Determining the right amount requires a personal assessment of what might go wrong in your life and how much it will cost to fix it.
“For example, if you own a house, there is a lot more that you will need to replace if broken or worn down [such as] appliances, a boiler, an A/C unit or a driveway, whereas renting this is covered,” Kelly says. “Additionally, it depends on the amount of insurance coverage you currently have. Having high deductibles on your car insurance, for instance, means you would need cash to cover that deductible and would require more on the rainy day fund.”
When forecasting for rainy days, consider the rest of your family, too. If you have children, a rainy day fund may help pick up the bill for a doctor’s visit that isn’t totally covered by insurance. It may also be used to cover the price tag of a medical procedure for your pet.
How to set up a rainy day fund
Just as you keep your umbrella handy for those real rainy days in the forecast, you’ll want to set up your rainy day fund to keep your funds easily accessible. Instead of locking up the funds in a certificate of deposit, find a Federal Deposit Insurance Corp.-insured account that allows for quick and fee-free withdrawals. High-yield savings accounts and money market accounts are two great options.
“You want to keep that money in a highly liquid account,” Kelly says. “The best would be to find a simple money market savings account that gives at least some form of interest but allows you to withdraw the money at a moment’s notice with no concern of the market status.”
Featured image by Friends Stock of Shutterstock.