What It Is And Why You Should Save For One – Forbes Advisor

Unexpected expenses are unavoidable. And while savings levels hit historical highs at the onset of the Covid-19 pandemic, they dropped significantly just two years later, according to the Federal Reserve Bank of St. Louis.

Whether it’s a medical emergency, car repair or a high utility bill, financial surprises are rarely pleasant. But a rainy day fund can lessen the stress of an emergency and help you avoid a financial crisis when they do occur.

What Is a Rainy Day Fund?

A rainy day fund is a dedicated cash reserve set aside to cover unexpected expenses. It acts as a financial buffer that can be used to cover random bills or unanticipated increases in the cost of living so you can avoid financial setbacks. The idea is to have enough money saved to avoid using a credit card or taking out high-interest loans to pay for these financial surprises.

Rainy Day Fund vs. Emergency Fund

Think of a rainy day fund as savings to handle minor inconveniences and unexpected costs. Like the name implies, it’s intended to help you weather the small challenges life throws at you. Be it medical bills, car repairs or broken appliances, a rainy day fund can help make an unpleasant extra cost bearable.

Emergency funds are larger and designed to cover the storms of life—so you’re protected during ongoing financial challenges like job loss. Financial experts recommend saving three to six months’ worth of living expenses. Some even recommend saving up to a year of living expenses.

How Much Should I Save in My Rainy Day Fund?

Personal finance experts suggest saving between $500 and $2,500 in a rainy day fund. But the amount of money you’ll want to save depends on your individual circumstances. Take stock of your household appliances. If your water heater or furnace are old, consider pricing out an emergency repair and set that amount as your goal.

It’s important to assess your own financial situation and determine the right amount of savings for you and your family. But don’t be daunted by the numbers. Having something in a rainy day fund is always better than nothing.

Begin with an attainable goal, and set aside a little each month until you reach that number. If possible, set up an automatic transfer to ensure you make regular contributions. Once you hit your goal, you can determine if that’s sufficient or if you should keep building your fund.

Why Is a Rainy Day Fund Important?

Extra expenses can easily snowball, with one unexpected bill causing you to fall behind on others. But a rainy day fund can keep life’s little annoyances from becoming crises.

Reduces Financial Stress

Financial stress can wreak havoc on your mental and physical health and negatively impact your work and relationships. Having a financial buffer can provide more stability and peace of mind.

Puts You Back in Control

So much in life is out of your control—flat tires, emergency room visits or climbing grocery costs. Having a financial cushion may provide a sense of empowerment when things feel out of your control. Being prepared for the unexpected provides you with options and allows you to act quickly.

Helps You Avoid Debt

Without a rainy day fund, some people end up turning to high-interest debt, such as credit cards or personal loans, to cover unplanned costs. A well-stocked rainy day fund allows you to handle financial challenges without incurring additional debt.

Where To Keep a Rainy Day Fund

It’s best to keep your rainy day fund in a savings account at a bank or credit union. These accounts offer low risk and allow you to access your funds quickly and as needed.

When choosing a savings account for your rainy day fund, consider a high-yield savings account. While the interest rates vary, an interest-earning account can help your fund grow faster over time. To save money, look for a no-fee savings account.

If you’re worried about losing money, make sure you open the account at an FDIC-insured bank or NCUA-insured credit union. This type of insurance protects your money against bank failure, up to $250,000 per depositor, per institution and per ownership account.