The importance of a rainy day fund
We all hope that it never rains (unless we’re trying to save on watering the plants, but that’s another topic). But, alas, sometimes it does. After the tragedies of Hurricanes Katrina and Rita, we heard numerous stories about families without a dime in the bank to pay for food, shelter, and clothing while the wage earners were looking for new work.
Catastrophes like a hurricane –a medical emergency, an accident, or the loss of a job – are a few reasons why financial advisers recommend that you have at least three months worth of income in savings. Basically, an emergency savings fund is designed to protect you and your way of life if you aren’t able to work (and earn money) for a while.
But emergency savings funds can also help with unexpected expenses that pop up, like the air conditioner giving out in the middle of July, or the family’s only car traveling its last mile. Unexpected expenses like these do come up, and can be very hard to deal with without an emergency savings fund.
Many people who don’t have an emergency savings fund end up paying emergency expenses with the credit card. But then interest begins to build, which means that it will be increasingly more difficult to pay off the credit card debt once they’re back on their feet. To learn about different investment options for your rainy day funds, read on . . . or click here.
Where to put rainy day funds
Unlike a retirement or college savings account, which are usually set up long before withdrawals will be made, an emergency savings fund needs to be relatively liquid (meaning that money can be taken out fairly easily without large penalties). The most obvious place for an emergency savings fund, then, is in a money market account (MMA) or even a traditional savings account.
The downside to a MMA or a traditional savings account is that both earn relatively low interest (at 1.05% and 3.10% at last check for a no-minimum-balance account). A money market account with a higher minimum balance requirement ($10,000) may earn a bit more, 3.44% at last check. In comparison, a 5-year CD might earn 4.84%, while a more liquid 6-month CD might earn 4.40%, though many CDs have early withdrawal penalties that can erase interest earnings or even reduce the principal.
Other options include U.S. savings bonds, though you may not be able to sell a bond within the first 6-months or 1-year that you own it. Remember, while you always want your money to be working for you as hard as it can, the goal of a rainy day fund is not to generate investment income. The goal is to give you a cushion to land on if you come upon hard times. The cost of having money in an emergency savings account is that you can’t invest it in a higher-yield generating investment, but the benefit is that if an emergency arises, you won’t have to pay interest to borrow money.
To start your emergency savings fund, determine how much of your monthly budget you could carve out to put away into savings and how long – at that savings rate – it would take you to build up three months’ worth of expenses. Start today by exploring the different emergency savings fund options. Click here!
