Emergency and Rainy-Day Funds: Expect the Unexpected
Financial plans can get derailed when unexpected expenses pop up. Find out how having two different backup strategies can help you get through stressful times.
Key Takeaways
Having both emergency and rainy-day funds for different purposes can help keep you from being overwhelmed by unexpected expenses.
There are a variety of accounts that give you access to your money when you need it and the potential to earn some interest when you don’t need it.
Building up and maintaining robust fallback funds may help you weather life’s unexpected financial challenges with confidence.
Most people would like to see nothing but blue skies. But storm clouds do roll in at times, which can suddenly disrupt plans. When it comes to your finances, a disruption in your plans can come from unexpected expenses. And that’s where an emergency fund—and a rainy-day fund—can come in handy.
Why would you need a rainy-day fund if you already have an emergency fund? Because each can serve a distinct purpose that helps keep you from being overwhelmed.
Get practical insights on how to start and maintain both types of funds to help prepare yourself for financial surprises.
Emergency Fund vs. Rainy-Day Fund
Emergency Fund
This fund is designed for major, unexpected situations that can significantly impact your long-term financial stability, such as a medical emergency, an unexpected car replacement or a job loss.
Many financial professionals recommend having enough money in an emergency fund to cover your daily living expenses for three to six months. Some people might want more.
Unemployment Can Last Longer Than You Expect
Unemployment is a lagging indicator. It tends to rise as the economy is under stress. The average duration of unemployment since 2000 has been about 5½ months.
After the Great Recession of 2007-2009, average time spent unemployed lasted up to 9 months. Following the COVID-19 pandemic, the average unemployment duration peaked at roughly 9 months.*
Rainy-Day Fund
This fund is for smaller, less severe unexpected expenses. Think about the expenses that seem to pop up at the worst times: A car repair, an appliance that stops working, a series of smaller medical bills, an unscheduled school fee—“little” things that can add up quickly.
Having backup funds that are easy to get to can help relieve the financial pressure. For a rainy-day fund, aim for a savings target that you believe will lessen the stress of covering the smaller surprises, maybe $1,000-$2,000.
3 Steps to Build Your Emergency and Rainy-Day Funds
Set savings goals. Determine how much you want to save for both funds and set realistic timelines. Begin with manageable amounts and gradually increase over time.
Create a budget. Identify areas where you can cut back and put that money to savings. Regardless of how much you make, budgeting is the only way to take control of your money. It might help to think of it not as a limitation but as a way to determine what you can comfortably spend on nice-to-have discretionary items.
Automate savings. Set up automatic transfers to your emergency and rainy-day funds to ensure consistent contributions. Committing to actions today can help prevent your future self from acting in ways that sabotage your goals.
Unexpected Expenses—Are You an Over Estimator or Under Estimator?
Overestimating unexpected expenses isn’t necessarily bad; however, you may be able to spend more than you think. Under estimators may need to revisit this category.
Those who constantly feel their budget is wrecked by unexpected expenses may not have enough savings. A telling sign is that you are shocked by how often unplanned costs set you back. If you find yourself blowing through the unexpected expenses line on your budget, you may need to take a more realistic look at those expenses.
Where Should You Put Your Money?
The idea with both funds is that you want to have relatively easy access to your money when you need it but still have the potential to earn some interest when you don’t. Consider the following short-term, highly liquid options, sometimes called cash equivalents.
Traditional savings accounts at a bank or other financial institution are often the first place people think of to start building their savings while being able to make withdrawals when they want. Keep in mind that these savings accounts, particularly higher-yielding ones, may come with fees for withdrawals and other transactions, so be sure to know the financial institution’s policies.
Money market accounts are offered by banks and other financial institutions that function similarly to other deposit accounts and may provide higher interest rates than typical savings accounts. Many money market accounts are insured by the Federal Insurance Deposit Corporation (FDIC) or National Credit Union Administration (NCUA) for up to $250,000.
Money market funds are a type of mutual fund and invest in assets that are generally easy to convert to cash. Some offer check-writing and other features. They are not insured by the FDIC or NCUA. However, money market funds are protected as securities by the Securities Investor Protection Corporation (SIPC) for up to $500,000 when held in a customer’s account at a brokerage firm. The firms that offer these funds also must follow Securities and Exchange Commission (SEC) rules.
Certificates of deposit (CDs) may feature attractive interest rates for committing your funds for a period of time, and they usually have penalties for early withdrawals. Therefore, they may be more appropriate for emergency funds than for rainy-day funds.
Tips for Maintaining Emergency and Rainy-Day Funds
Stay disciplined. Use your emergency fund only for true emergencies and your rainy-day fund for smaller, unexpected expenses.
Pay yourself back. If you need to dip into either fund, make it a priority to replenish the account as soon as possible.
Review funds regularly. Assess your funds periodically to ensure they still meet your needs and adjust your savings goals if necessary.
Use cash windfalls. Consider allocating a portion of unexpected cash windfalls, such as tax refunds, bonuses, or gifts, directly to your emergency and rainy-day funds.
3 Common Mistakes to Avoid When Saving for the Unexpected
Not starting. The best time to start saving is now, regardless of your financial situation. Starting small is better than not starting at all.
Underestimating expenses. Be realistic about your monthly expenses to ensure your funds are sufficient.
Not repaying yourself. Failing to replenish your funds after use can leave you vulnerable to future emergencies.
Thinking of Using Retirement Money for Emergencies? It Can Set You Back
Creating an emergency fund can take months or years, especially if you run into setbacks and need to use those savings. But the risks of not having one can be greater.
While some accumulate credit card debt or take out loans in an emergency, others may draw on retirement or other long-term investments. Investors with an IRA or employer plan who are younger than 59½ may be able to withdraw those funds—but may face a 10% penalty as well as income tax. Even without the penalty or taxes, your future plans for your IRA money can be derailed.
Similarly, parents who have a 529 account for their child’s college education can withdraw money for emergency reasons, but they will owe income taxes and a 10% penalty on the earnings. Not only that, but you may find it difficult to build up the college fund again depending on the amount of the withdrawal and when you need to use the money.
Emergency and Rainy-Day Funds Give You Fallback Options
Building and maintaining both an emergency fund and a rainy-day fund is a vital step toward your future financial security. By following these tips and strategies, you can have robust fallback funds that may help you weather life’s unexpected financial challenges with confidence.
Our financial consultants can help you with financial planning, either in a session or two or ongoing with our in-depth financial planning and advice service. However you choose to plan, we’re here to help.
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Source: U.S. Bureau of Labor Statistics, Average Weeks Unemployed, retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/UEMPMEAN, September 30, 2024.
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