BudgetingManage Money ArticlesSavings

Emergency Fund: Why You Need It and Why It Matters

The two types of emergency savings accounts are the rainy day fund and the opportunity fund.

I once read that nearly half of Americans don’t have $500 saved to cover an unexpected expense. Back then, I was part of that statistic and felt the stress of being financially unprepared. Today, I’ve made it a mission to emphasize the importance of saving money for rainy days, emergencies, and unexpected job loss.

What is an Emergency Fund?

An emergency fund is a savings account used to cover emergencies. The term emergency is quite financially vague, with people associating it with either having a flat tire or losing income. But all agree that an emergency doesn’t include buying new clothes, gifts, or a night out with friends.

I define an emergency fund as a savings account used specifically to cover periods of underemployment or unemployment. It’s an emergency when your income stops. Without a source of income, you may be unable to pay for rent, food, and utilities. That is a state of personal emergency.

2 Emergency Savings Accounts

I’ve learned how helpful it is to have two savings accounts dedicated to unexpected situations. The two types of emergency savings accounts are the rainy day fund and the opportunity fund.

Rainy Day Fund

Rainy day funds are meant to cover unexpected and occasionally smaller expenses. The fund is used for rainy days, which include getting a flat tire or receiving an unexpected medical bill.

The fund reduces stress by removing the financial component of an emergency. It provides you peace of mind and quick access to cash to set things right. While a $300 repair to your car may not seem like a lot, it can throw off your monthly budget, creating a ripple effect on your finances.

How much to save in a rainy day fund

I recommend having at least $500 in a rainy day fund or the amount of your auto insurance deductible. It’s a clear target to aim towards. Some studies show people don’t have enough savings to pay for their insurance deductible after a car accident. So their car sits in the car shop, racking up storage fees.

I keep $1,000 in my rainy day fund to cover, at the minimum, my deductible. It’s been useful in helping me pay for the unexpected emergencies that arise.

Save the money with your primary bank so the cash is immediately accessible.

How to start a rainy day fund

  1. Open a savings account with your primary bank and title the account “Rainy Day Fund.”
  2. Transfer $500-$1000 or automatically transfer a small amount each payday until you reach the goal.
  3. You’ll want to replenish the account after using the money in the fund.
  4. Review and revise your rainy day fund requirements. Your life and finances change, so you’ll want to ensure your fund reflects those changes.

Find the best savings accounts in the phroogal marketplace.

Opportunity fund

An opportunity fund is a type of emergency savings account. The fund helps cover basic living expenses when you lose your job, your hours are reduced, or you’re sick, disabled, or hospitalized. The fund covers your basic needs until you can find another job or income source.

The opportunity fund is just a better way to think about the time when you unexpectedly lose your job, hours are reduced, or you’re hospitalized. I recommend saving at least 6 months of basic living expenses to support you during a “no income coming in” emergency.

I call it an opportunity fund because you regain the time you once spent at work to explore new job opportunities with less financial stress.

The lack of time often keeps us from pursuing opportunities. An opportunity fund is a way to turn an otherwise negative experience of losing a job into an opportunity to explore interests. It can also be used for once-in-a-lifetime business or investment opportunities.

How much to save in an opportunity fund

With an opportunity fund, you’re not saving 6 months of income but rather 6 months of living expenses. Living expenses include housing, utilities, cell service, food, and transportation.

For example, your monthly living expenses are $1500. Your goal is to save $9,000 in the fund to cover six months.

Tip: The lower your basic living expenses, the lower your savings goal will be. If you can lower your basic living expenses to $1200 per month, you’d reduce your goal to $7,200.

How to start an opportunity fund

  1. Calculate your basic living expenses. You can do this with the help of the budgeting process.
  2. Open a savings account and name it “6 Month Opportunity Fund $X,” with X being your goal amount. So it would look like a “6-month Opportunity Fund of $9,000.”
  3. Set up automatic transfers into the account each pay period.
  4. Remember to replenish the fund every time it’s used.
  5. Review and revise your fund amounts. Your life and finances will change, and your funds should change, too.

Find the best savings accounts in the marketplace.

Should you have this money-earning interest?

Ideally, your money should be easily accessible and liquid, meaning it’s cash or can easily be turned into cash and in an interest-bearing account. I currently have my Rainy Day Fund with my credit union and my Opportunity Fund in multiple certificates using a CD ladder strategy of 1-36 months.

How to Start Saving for Emergencies

Start small and build the account with automatic savings transfers each pay period. Start a savings habit with as little as $5 and incrementally increase as you adjust priorities. Ideally, the more you save the faster you’ll reach the goals.

  1. To start the two emergency savings accounts, open accounts at your bank or credit union. You can ask to have this account renamed, as mentioned above.
  2. The goal of the rainy day fund is to save at least $500, which is the amount of your auto insurance deductible. This gives you a target.
  3. For the opportunity day fund, total your basic monthly living expenses and multiply by 6 (months) to get your target goal.
  4. For both funds, set automatic transfers or deposits into each account until you’ve reached your targets.
  5. Replenish your funds as soon as you can after each use.
  6. Review and revise your funds as your life and money situations change.

Supplementing your income might be necessary to fund your savings. Find a side hustle, work from home, use apps, and more to make extra cash.

Why Emergency Savings Funds Matter

1. You Can Avoid Credit Card Debt

Unexpected expenses are going to happen. It’s not a question of if an emergency will happen but when. And unfortunately, if you don’t have emergency savings, the only alternative might be using a credit card.

Using credit isn’t a terrible backup plan if you can afford to pay off charges every month. But if you can’t, having emergency savings is the best way to prepare in advance and avoid a ton of interest.

2. You Won’t Have to Borrow from a Retirement Account

If you have a 401(k) plan through your work or an individual retirement account, don’t consider these accounts an emergency fund. Taking early withdrawals from a retirement account is costly. There’s a penalty and you’ll pay interest on any withdrawal. Of course, tapping retirement accounts might be the only way to get cash if you don’t have any emergency savings. Unfortunately, that will cost you in the long run.

3. You Don’t Have to Get a Costly Payday Loan

Payday loans and title loans are costly and risky. If your back is up against the wall and you need fast cash, these loans may seem the only doable option since they don’t involve credit checks. But you’ll receive an interest rate higher than most traditional loans, and with title loans, there’s the risk of losing your car if you default.

Emergency savings means you don’t have to rely on alternative lending to get through a tough time.

4. You Can Avoid Late Fees

If you use money allocated for bills to cover an unexpected expense, there’s a greater chance that you won’t have enough to cover monthly expenses. You might get hit with late payment fees that range from $10 to $45.

5. You Can Maintain Your Dignity

If you don’t have emergency savings and are running out of options, borrowing cash from family or friends might be the only option. There is nothing wrong with asking for help, but it can strain relationships. If you cannot repay the money, it can drive a wedge or create tension in the relationship. All of this can be avoided with emergency savings.

Related Articles

Leave a Reply

Your email address will not be published. Required fields are marked *