Life is full of surprises. Some are pleasant like finding money in your pocket or getting a promotion at work. Others are not so pleasant like losing your job or facing an unexpected medical bill. How do you prepare for these unforeseen events that can disrupt your finances?
The answer is simple: you need a financial back up plan.
A financial back up plan consists of two types of savings accounts: an emergency fund and a rainy day fund. These accounts are designed to help you cope with different kinds of unexpected expenses without going into debt or compromising your long-term goals. In this article we will explain what these funds are, how much you need to save for them, where to keep them and how to build them.
What Is an Emergency Fund?
An emergency fund is money that you set aside for major life emergencies such as:
- Losing your job
- Getting divorced
- Having a serious illness or injury
- Experiencing a natural disaster
- Facing legal issues
An emergency fund is meant to cover essential living expenses such as rent, mortgage, food, utilities, insurance, transportation, health care etc. for at least three to six months depending on your situation. An emergency fund can help you avoid using credit cards, taking out loans or tapping into your retirement savings when faced with a crisis.
According to Bankrate 1 only 43% of Americans have enough savings to cover a $1000 emergency expense while 18% would use their credit card, 12% would borrow from family or friends, and 5% would take out a personal loan.
Having an emergency fund can give you peace of mind knowing that you have a cushion to fall back on if something goes wrong. It can also help you maintain your lifestyle, avoid accumulating debt, preserve your credit score, reduce stress and anxiety, improve your mental health, boost your confidence and resilience.
What Is a Rainy Day Fund?
A rainy day fund is money that you set aside for smaller unanticipated expenses such as:
- Buying new tires or repairing your car
- Replacing or fixing an appliance
- Paying for dental work or vet bills
- Covering school fees or extracurricular activities
- Treating yourself to something nice
A rainy day fund is meant to cover one-time non-recurring expenses that are not part of your regular budget but that can still throw you off track if not planned for. A rainy day fund can help you avoid dipping into your emergency fund using overdraft protection, paying late fees, missing payments or sacrificing other goals.
According to NerdWallet 2 having dedicated rainy day savings can help you weather irregular expenses and maintain financial stability while saving more than $500 per year on average by avoiding overdraft fees, interest charges, late fees etc.
Having a rainy day fund can also give you flexibility, convenience, satisfaction, enjoyment, gratitude , generosity, spontaneity, creativity and fun.
How Much Do You Need To Save For Your Emergency Fund And Rainy Day Fund?
The amount of money that you need to save for your emergency fund and rainy day fund depends on several factors such as:
- Your income level
- Your monthly expenses
- Your debt obligations
- Your family size
- Your lifestyle preferences
As a general rule of thumb experts recommend saving three to six months’ worth of living expenses for your emergency fund 3 4 which can vary from $10 000 to $50 000 or more depending on your income level.
For your rainy day fund experts recommend saving $500 to $2000 5 6 which can cover most common unexpected expenses.
How To Save For Your Emergency Fund And Rainy Day Fund?
Saving for your emergency fund and rainy day fund may seem daunting especially if you have other financial goals or obligations. However there are some strategies that can help you build your emergency savings faster and easier such as:
- Choose the right savings account: Not all savings accounts are the same. Look for an FDIC-insured high-yield savings account that offers a competitive interest rate with no fees , no minimum balance requirements and easy access to your money. This way you can earn some interest on your savings while keeping them safe and liquid 7 8.
- Get a cashback credit card: Opting for a cashback credit card is a smart way to save money which you can use for unexpected expenses or a future emergency. These cards often give you the benefit of cashback on all your purchases, putting money back into your pocket. This provides you with a convenient way to save up for a rainy day 9.
- Pick up a side hustle: If you have some spare time skills or talents that you can monetize consider picking up a side hustle to earn some extra income. Then dedicate all or part of your earnings to your savings accounts 10.
- Automate your savings: One of the easiest ways to save money is to automate it. You can set up a direct deposit from your paycheck or a recurring transfer from your checking account to your savings account every month or every week. This way you don’t have to think about it or rely on your willpower 11 12.
- Cut back on unnecessary expenses: Another way to save money is to reduce your spending on things that are not essential or important to you. You can use budgeting apps like Mint YNAB Personal Capital etc. to track your expenses and identify areas where you can save more such as dining out, entertainment subscriptions, clothing etc.13 14.
The Benefits Of Having A Financial Back Up Plan
Having a financial backup plan, consisting of an emergency fund and a rainy day fund, can provide several benefits, such as:
- Peace of mind knowing that you have a cushion to fall back on if something goes wrong
- Maintaining your lifestyle during unexpected expenses and financial situations
- Avoiding accumulating debt
- Preserving your credit score
- Reducing stress and anxiety
- Improving your mental health
- Boosting your confidence and resilience
- Flexibility to handle irregular expenses
- Convenience in handling unexpected but necessary expenses
- Satisfaction, enjoyment, gratitude, generosity, spontaneity, creativity, and fun when using your rainy day fund for something nice
- Avoiding overdraft fees, interest charges, and late fees, which can save more than $500 per year on average
- Ensuring that you can cover essential living expenses such as rent, mortgage, food, utilities, insurance, transportation, healthcare, and more for at least three to six months in case of a major life emergency.
- Avoiding using credit cards, taking out loans, or tapping into your retirement savings when faced with a crisis.
- Protecting you from financial hardships caused by unforeseen events such as losing your job, getting divorced, having a serious illness or injury, experiencing a natural disaster, or facing legal issues.
Therefore, it is essential to prioritize building your financial back up plan to safeguard your financial freedom, stability and well-being.
Having a financial back up plan with an emergency fund and a rainy day fund is one of the best ways to protect yourself from unexpected events that can disrupt your finances. By saving money for these funds you can enjoy the benefits of having a cash reserve financial security wealth accumulation financial planning and financial well-being. To get started with your financial back up plan you can follow these steps: assess your current situation, set your savings goals, choose your savings accounts, automate your savings and cut back on unnecessary expenses. With these tips and tools you can build your financial back up plan faster and easier than you think.