No matter how prepared you are, life always finds a way … to slap you in the face!
That’s a fact.
And it’s especially true for your financial life.
No matter how financially prepared you think you are, there will always be a car ready to break down when you need it most, insurance that won’t cover your daughter’s braces, or a boss who needs to lay off people on a whim.
There’s really not a lot you can do about these things, other than trying to be prepared as best as you can.
This article is all about showing you why a rainy day fund is the thing that will help you get a good night of sleep when everything else is on fire.
A rainy day fund, also known as an emergency fund, is a certain amount of liquid savings set aside to cover those things life throws at you when you think everything is going well.
The important word in that last sentence is ‘liquid.’ When your car breaks down, you don’t want the money for its repair to be tied up in some other asset. You need it now!
I’ll show you how to achieve this in a minute.
Think of it as a life vest; ideally, you will never use it — but you’ll be glad it’s there when you actually have to.
But even if you don’t ever need it, just knowing that it’s here can do a lot for you psychologically.
Off the top of my head, I can think of a bunch of scenarios where you will love yourself for putting some money towards your rainy day fund every month. Here are three of them:
You lose your job. Now, you might be an expert in a highly sought after field, and you already had a bunch of good job offers anyway. Good for you.
But not everyone is this lucky. Living on an unemployment budget can be a huge adjustment for you and might lead to having to take the next best job that comes along. Not only might this not be the job you were hoping for, but you’re also negotiating your salary out of a position of need.
Now imagine a situation where you can actually look for a job that suits you because you know you can make it another month or two without ending up on the street. Having a rainy day fund can do just that.
You break it off with your significant other and feel uncomfortable living at home. If you find yourself living in an uncomfortable environment, moving is probably your best option. Unfortunately, this can turn out to be a real challenge without the proper funds or the help of your friends.
Your tax bill is bigger than expected. You really don’t want to owe money to the government.
Having an emergency fund for situations like these will help you keep a level head in a stressful time.
If you’re living without a safety cushion, you’re living on the financial edge — hoping to get by without running into a crisis.
An emergency fund can also keep you from making bad financial decisions. You might be tempted to get money from wherever you can in a time of need. In the worst case, this may result in a mountain of debt.
This is a tricky question. You obviously want to be able to pay for unexpected repairs and get by in a time of financial insecurity, but the money you put in your emergency fund is also the money you don’t put towards your other savings goals and investments.
Traditionally, you should keep enough money in your rainy day fund to be able to finance your essential costs of living for at least three months.
So, if you spend €1000 a month on rent, food, insurance, and whatever else you can’t live without, you should aim for at least €3000 in emergency savings.
I recommend to not cover more than six months of your essential living costs with your emergency fund. Three to six months should be enough to get you back on your feet in most cases anyway.
See, the problem with liquid assets is that they usually don’t increase in value. Inflation and low-interest rates will make sure that your accessible cash won’t be worth the same over a period of time.
You might be missing out on a chance to let your money make more money when you put it towards of your emergency fund instead of your savings goals or an investment with less liquidity but higher interest rates.
Once again, you need to make sure that you can actually access the money you’ve put away for an emergency when you’re in an emergency.
This isn’t the case when your money is tied up in a real estate investment for example.
The kind of liquidity you should be aiming for is the kind where you can go to an ATM and get cash right away.
Cash or a savings account will probably be your best choice.
Again, low-interest rates and inflation won’t be on your side, but you also won’t have to wait for your money or find a broker first, like you would if you were trying to sell off stocks or gold to get some cash.
You should put a part of your monthly income towards your rainy day fund — at least until you’ve saved up an amount you’re comfortable with.
In my post about budgeting, I recommend using around 20% of your monthly net income to go towards your savings goals.
Depending on your financial situation, you might be able to put the whole 20% towards your rainy-day-fund, but realistically speaking, you probably also have other financial responsibilities that you need to take care of.
If you need help balancing your budget, making sure you don’t spend too much money on the wrong things, and if you aren’t familiar with the 50/20/30 rule of budgeting, I highly recommend checking out this article.
To wrap this post up, here is a list of things that will help you figure out if your emergency is an “emergency fund”-emergency:
You forgot to save some money for your mother’s birthday. Definitely not a pleasant situation to be in, but also not an actual emergency. Maybe set up a reminder for next year. It’s not that hard.
You forgot to save some money for your mother-in-law’s birthday. Oh boy, good luck with that. That’s a different emergency altogether. Still not enough of an emergency to raid your rainy day fund, though.
Your car breaks down, and you rely on it to do all the important things in your life. Yes. This is an actual emergency.
Your pet gets sick, and you have to cover the cost of the vet. Definitely an emergency. No doubt about it.
Flatscreen TVs are 30% off this week. Indeed a cool thing, but not an emergency. Sorry.
Your dishwasher breaks and floods your home. This has emergency written all over it. You might be insured against this kind of thing, but maybe you’re not. This is a prime example of a good emergency fund use.