Reasons to Keep a Rainy Day Fund
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As much as we may try to predict the future, life always comes up with a way to throw us a curveball. Although you might not know what form your next unanticipated expense is going to take, rest assured that it's going to come at some point. With that in mind, a cornerstone of a good financial plan is setting aside money for a rainy day fund.
Liquidity in Case of Emergency
The most basic purpose of a rainy day fund is to provide a source of funds when you find yourself in the middle of a financial thunderstorm. Whether it's the loss of a job, unexpected medical bills or your car suddenly breaking down, having a sufficient emergency fund allows you to use that money to pay the bills without having to go into debt. "In general, many advisers advocate saving six months worth of expenses," notes Anika Hedstrom, MBA and senior financial analyst practicing in Medford, Oregon. However, she also says that's just a rule of thumb that can vary from person to person: "I believe you should make it specific to your particular situation. Certain elements, including geographic location, fixed and variable expenses, age, dependents, area of expertise and demand for your skills/services/product should be considered in deriving the amount."
Peace of Mind
Having a rainy day fund can help reduce your financial-related stress, helping you get a better night's sleep because you're not concerned about the "what ifs" of life: if an emergency does arise, you have it covered. Also, keep your emergency cash accessible, so that you can use it when you need it. "This fund is not for investment purposes," cautions Hedstorm. "It needs to be in a secure, liquid vehicle such as a savings account or money market fund. I recommend a separate account, perhaps through an online bank, that is not tied to an ATM card. This makes the funds a little more difficult to access, which suits its purpose."
Power to Be Patient
Having a rainy day fund can also allow you the flexibility to make the life decisions you want -- and not have those decisions dictated to you. "Beyond the financial benefits, having an emergency fund puts you in a position of power," says Hedstrom. "For example, if you lose your job, you are not forced to take the first one that comes along and are able to focus on finding the right fit." That way, you can select a position that is at least closer to where you want to be long-term, which could mean more job security and higher wages in the future -- just because you were disciplined enough to build your emergency fund.
Building Financial Discipline
Financial planning isn't something most people one day wake up and are suddenly good at. Putting money in a rainy day fund helps establish a habit of saving. If you haven't started a rainy day fund yet, starting small helps to get the ball rolling. "Don't get hung up on the amount you are contributing or what you can afford to contribute," suggests Hedstrom. "Rather, focus on the action itself. For most people, it can take some time to get their account funded to the level they need. This is very normal and expected. Once you set up your separate account, enable an automatic deposit so part of every paycheck funds the account." Hedstrom also advises being creative if you're having a hard time coming up with the extra cash to start saving. "Consider alternative sources of funding to get started," she says. "For example, have a garage sale or consign clothing and use the funds to get a jump-start."