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Rainy day fund vs. emergency fund: What’s the difference?

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“Expect the unexpected” is a saying that’s been around a long time. It’s wise advice when you’re evaluating the amount of money you have set aside for a time when something happens that you just didn’t see coming. This can be something inconvenient, like the brakes on your car needing to be replaced, or something more extreme like losing your job.

In either case, you’re going to need to get out your checkbook to pay for the unforeseen. That money is going to have to come from somewhere.

There are two very likely sources for you to dip into when you need funds to pay for extraordinary expenses:

  • Your rainy day fund
  • Your emergency fund

You may be scratching your head at this point, thinking that they’re the same thing. But, most financial gurus will tell you they’re not. Let’s take a look at both, see what their purposes are, and examine how much you should have in each type of account.

Rainy day funds, explained

The person who coined the phrase “Rain is just confetti falling from the sky” wasn’t writing it when they had $250 in their checking account and had an unexpected bill for $500 come due.

A rainy day fund is intended to pay for smaller, unexpected expenses that come up during the course of daily living. Your monthly budget allows for such things as groceries and utilities, but it doesn’t include line items for large veterinary bills or auto repair costs. The money for expenses like this has to come from somewhere.

The rainy day fund is perfect for scenarios just like these. It’s a fund that isn’t intended to pay your mortgage for six months; it’s savings you’ve set aside expressly for smaller, unexpected expenses that you’ve not budgeted for.

Why couldn’t you just use your regular savings account to pay for these expenses? Maybe you can, but according to a poll conducted by Statista in December of 2019, nearly 70 percent of Americans have less than $1,000 in savings, with 45 percent having nothing saved.

You don’t need to fret if you’re part of these statistics, but you do need to start saving immediately. How much? For now, as much as you can. You’ll want to sit down and do a complete budget analysis, putting your income and all of your expenses down on paper. You’ll then want to look at what expenses you can trim to balance your budget with an amount left for savings — no easy chore.

You’ll likely have to make some spending cuts to free up money for your rainy day fund. Upon review, you may see that you could cut back on dining out, ordering in, or reducing the number of streaming services you watch each month. This may free up $50 per month; it may free up $250. Whatever the amount is, it’s a start.

Ideally, you’ll want to accumulate at least three months of living expenses in your fund. If that amount is $7,500 and you can set aside $200 per month for your rainy-day fund, you’ll have what you need in about three years. That may sound like a daunting task, but if you knew you’d need that amount in three years for life-saving surgery, you’d find a way to have it.

The rainy day fund should be in a separate account, not lumped in with your regular checking account. You want it to be easily accessible, but not co-mingled with other money that makes it easy to spend on a whim. Dedicated checking accounts or money market funds are perfect savings vehicles for these funds.

Emergency funds, explained

If a rainy day fund is intended to pay for the minor inconveniences of life, think sick pet or major appliance breakdown, then the emergency fund is for the unexpected deluge, like losing your job and needing money to pay your mortgage.

In the job loss scenario, it will take an average of just over six weeks to find new employment, according to recruiting company Jobvite. In the current era of COVID and an unemployment rate of over 8%, it can take considerably longer than during periods of pre-COVID unemployment, which hovered at around 3%.

If the savings for a rainy day should be at the three months of living expenses level, it stands to reason that a different fund for more dire circumstances should be even better funded. And that is the case.

Many financial planners advocate having as much as six months of living expenses in your emergency fund — even more if you’re self-employed or a single-income family. This may seem to be a yeoman’s task, but it can be done.

Much like determining how much money to have in your rainy day fund, the same thorough analysis should be conducted for the emergency fund. Systematic deposits should be made into a separate account dedicated to the emergency fund. This can be a checking account, money market account, or an account associated with higher interest rates, such as a bond fund. Stock funds should be avoided because of the risk of loss of capital.

Prepare for the unexpected

During these accumulation phases of your financial life, the unexpected can inconveniently make an appearance. It’s wise to be prepared even when you’re nowhere near being at healthy savings levels.

For example, you may want to purchase pet insurance just in case Fido needs emergency surgery because he swallowed a sock. Or you may want to buy a home shield plan to help with unexpected expenses pertaining to your home, such as an HVAC system needing to be repaired or replaced.

Having long term disability insurance is another safeguard in case of extreme misfortune. These policies will provide you with up to 60% of income replacement if you become sick or injured and aren’t able to do your job. You’ll need this income to pay for monthly living expenses and potentially continue to grow your rainy day or emergency fund.

Don’t despair if you’re not where you want to be when it comes to these funds. Start where you can and work up from there. As Ben Franklin put it, “A penny saved is a penny earned.”

The information and content provided herein is for educational purposes only, and should not be considered legal, tax, investment, or financial advice, recommendation, or endorsement. Breeze does not guarantee the accuracy, completeness, reliability or usefulness of any testimonials, opinions, advice, product or service offers, or other information provided here by third parties. Individuals are encouraged to seek advice from their own tax or legal counsel.

— Published September 24, 2020
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