Establish 'rainy day fund' for emergencies

By Grace Allen | Sep 25, 2013

You have been there. The car breaks down. The roof leaks. A tooth needs capping. Or, the unthinkable happens — you lose your job. These unexpected events can play havoc on your financial security. An emergency fund, or what some may call a “rainy day fund,” is there to cover those surprises and out-of-nowhere expenses.

It does not matter how much money you make or how well things currently are — unforeseen events will occur and you need to be prepared.

A recent survey of 1,000 adults by Princeton Survey Research Association found that 76 percent of Americans lack sufficient emergency savings. Most financial planners will recommend that an emergency fund should include three to six months of living expenses.

However, some recommend as much as nine to 12 months. You only have to look back at the recent recession, where many Americans lost their jobs for more than six months, to realize that three to six months of savings may not be adequate. Without enough money socked away, you may be only months away from financial disaster.

Job security, family size, number of income earners in the household and other sources of income all play roles in how much money you should save in your emergency fund. If you work in an unstable industry or your job skills are not in high demand, your emergency fund should be on the larger size. Likewise, if you have dependents and/or you are a one-income family, a larger emergency fund would be advisable.

On the contrary, if you have other sources of income, such as investments or rental income, a smaller emergency fund would probably suffice. Don’t under estimate what your living expenses include. Fixed expenses such as car payments and mortgages are certainly included. However, you should also account for utilities, food, transportation, insurance and childcare — any expenses that cannot be put off without serious consequences.

It is not easy to fully fund your emergency fund. It will take time, so be diligent and patient. Save as much as possible each month by looking for expenses you can cut.

For example, you may decide to eat out less or focus on cutting your utility bills. Another excellent place to source your emergency fund is with unexpected cash flow such as a tax refund or gift/inheritance.

Since your emergency fund will most likely not be fully funded for several years, you should find other resources to bridge the gap. If you own your home, you could establish a home equity line of credit that could be accessed in case of an emergency. Investments that carry no or a low penalty to convert to cash is another place to find needed funds.

If you have little or no debt, a credit card can even be used to cover expenses when an emergency arises.

An emergency fund should be easily accessible but not too easy to avoid non-emergency withdrawals. Make sure that it is not comingled with your regular checking or savings account.

To eke out a little more interest than a regular savings account pays, use an online savings account, a money market account or short-term certificates of deposit.

Once you build about four months of expenses, consider investing the additional funds a bit more aggressively to enhance returns.

Life rarely goes as planned. To be prepared for those unexpected financial events, establish an emergency fund. This safety net will provide you with peace of mind and protect you from potential financial stress and damage.