Would you have enough money to pay your bills without running up credit card debt if you lost your job tomorrow? What if your car broke down and you needed $3,000 to get back on the road? Could you come up with the cash?
If you answered "no," you should create a rainy day fund, which is dollars that you can tap in case of a financial emergency. The benefit of such a resource is obvious: If you have one, you will not need to go into debt to handle the economic crises that so frequently pop up.
U.S. Consumers Not Ready For Emergencies
Not having a rainy day fund is far from unusual. For example, Bankrate's July 2021 Emergency Savings Survey reveals that 1 in 4 Americans do not have an emergency fund at all, increasing from 21 percent in 2020.
For those that can save, they aren't able to save enough. The same survey reports that 26 percent of respondents have saved less than three months' expenses, and 19 percent with three to five months' expenses. Twenty-five percent of Americans report having more than six months' expenses on hand, which is typically what financial planners recommend keeping.
Undoubtedly, the economic impact of a global pandemic still affects millions of Americans. For example, Bankrate's survey shows that 34 percent of respondents have fewer savings now than before the pandemic.
How will consumers without a rainy day fund handle emergency expenses? Many would borrow from family members or friends, while others say they would neglect a different financial obligation. Others would, of course, but the debt on their credit cards.
None of these are reliable options. The best bet is to have an emergency fund available. The good news? Starting an emergency fund is not overly complicated.
How Much Do You Need?
First, you have to determine how much money you need in your rainy-day fund. Most experts recommend having at least enough money in your emergency fund to cover three to six months of expenses. However, depending on the state of the economy or stability of employment, you might need more or less. Of course, the more money you have, the better. That is especially true in today's economy when it is still easy to lose your job and often challenging to find a replacement that pays the same.
To determine how much money you need, take a long look at your monthly expenses, including everything from your recurring bills -- such as your mortgage payment, car bill, and student loan payment. Then include those costs that vary from month to month -- everything from your grocery bills to your utilities and minimum monthly credit card payments. Add these and multiply them by the number of months you want to cover.
If your monthly living expenses come out to $4,000, you would need $12,000 for three months of emergency funds or $24,000 for six.
That is just the start of your rainy day fund. You will also need to budget savings for emergencies. What if your kitchen sink suddenly springs a leak and destroys the cabinet underneath it? What if your car needs a new transmission? What if you need medical care and your insurance only covers part of the procedure? These are all financial situations that could throw you deep into debt without an emergency fund.
It is hard to estimate how much you will need for these emergencies. According to American Family Insurance, you should look to save 1% of your home's total price for maintenance. So if your home costs $200,000, you should be looking to save $2,000 to cover costs. It could cost about $900 a year on average to maintain and repair a car that is five years or older. To be on the safe side, then, you might need to boost that $24,000 emergency fund to at least $27,000.
That amount might seem like an overwhelming sum of money to save. However, it is not.
No one expects you to save your money immediately. You will have to build your emergency fund over time. Start putting away whatever you can each month. That might mean cutting down on unnecessary expenses such as eating out, going to the movies, or buying that high-cost coffee on your morning commute.
It also helps to set up a direct deposit from your regular paycheck into the account holding your rainy day funds. Saving money is easier when you do not think about the money you are stowing away. With direct deposit, you never miss the money you are saving.
Where To Save It
Experts recommend saving your emergency fund dollars in an interest-bearing bank savings account.
There is a reason for that: You want to have easy access to the dollars in an emergency. With a savings account, you will tap your savings quickly. Moreover, if you have your dollars in an interest-bearing account, you will at least earn a bit of money. You will not get rich by having those dollars in a traditional savings account. However, you might make a bit of extra cash.
Many financial experts recommend that you start your rainy day fund before taking on other significant financial tasks such as paying off high-interest-rate debt. A fiscal emergency, if you do not have the cushion of an emergency fund, could throw your financials into chaos. If that occurs, a crisis could send your high-interest-rate debt soaring to new heights.
If you want to get financially healthy, the message is clear: It is time for you to commit to a rainy day fund of your own.