We all know that one of the only certainties in life is that the unexpected will occasionally happen. It’s important to have money put aside in case of unplanned expenses and costs, but saving for a car repair or a life-changing event needs different saving strategies. In this article, we explain the differences between the two key concepts of a rainy day fund and an emergency fund.
It’s easy to think that a rainy day fund and an emergency fund are the same thing, however there are some key differences that will help you to plan more safely and securely for your financial future.
This pot of money is there to help you cover smaller expenses to get you through to your next pay check, should you need it. The rainy day fund basically means that you can avoid taking out a payday loan or putting your expenses on a credit card. The rainy day fund should therefore contain between £500 and £1,000.
If your car breaks down or your washing machine starts spewing water onto the ground, you’ll need to easily access a few hundred quid to take care of the problem.
This fund should be kept liquid, i.e. in cash. This means that the best place for it will be in an easily accessible bank account, for example a savings account.
Once you do dip into this fund, you’ll have to start saving up to fill it again. This will help you have peace of mind when the next issue eventually comes about.
As the name implies, this fund is for the bigger unexpected challenges. If you really need to fall back on some money to keep your life going, then this will have the reserves you can dig into.
Your emergency fund should have enough cash to cover your average expenses for around three to six months. If you lose your job or fall ill then this money will be able to cover you and provide peace of mind in your immediate future.
In order to fill this fund you’ll have to work out your average monthly expenses and then multiply that in order to find your goal number. Finding out your average monthly expenses is an incredibly useful activity either way, as it will help you budget in your normal day-to-day life too.
As this fund will likely be in use much less often than the rainy day fund, it doesn’t necessarily have to sit in an easily accessible bank account where it will earn low interest levels. As this money may be untouched even for a few years, you might as well consider investment vehicles that could earn you some interest.
Of course, all investment comes with risk and you may lose money on your investments, so this decision needs to be carefully considered. It also depends on how easily and quickly you want to be able to access the money, as if it is invested it may take a few days to liquidate.
The first thing to do is to start putting money aside each month. This can be a small amount, such as £25 or £50, and if you do more – then great. One way to make this easier for yourself is to automate your savings.
As we’ve mentioned, the other thing to do is to work out your average monthly expenses so you know what your overall targets are. Another benefit is that you’ll have a better idea of how much money you can actually afford to put aside each month. Once you’ve done worked this out, try putting that money aside as soon as you get your pay check, rather than at the end of the month.
It might take a while to build up, but pretty soon you’ll have a rainy day fund and an emergency fund that are ready to support you when you need. After these key funds are covered, you can start thinking about saving for future financial freedom – all whilst knowing that if things go wrong, you’ll be covered.
“Financial peace isn’t the acquisition of stuff. It’s learning to live on less than you make, so you can give money back and have money to invest. You can’t win until you do this.” - Dave Ramsey, American Businessman