Why You Need A Rainy Day Fund And An Emergency Fund
What is the difference between a rainy day fund and an emergency savings fund?
The terms rainy day fund and emergency fund are often used interchangeably, however the two funds are similar but different. Both funds provide a buffer against unexpected financial costs and allow you to weather financial storms without resorting to credit cards, overdrafts or high interest short-term loans. Both funds should be liquid (i.e. readily available) and in an account that pays some interest e.g. an easy access savings account. Despite these similarities, they serve different purposes, a rainy day fund is dedicated to one-off expenses e.g. a car breakdown, while an emergency fund is dedicated to unexpected life changing events, such as sudden job loss. Unexpected events are already stressful in and of themselves, having a rainy day fund and an emergency fund in place prevents financial stress being added to your existing stress.
Which one should I save for first, a rainy day fund or an emergency fund?
Financial experts recommend saving for a rainy day fund first, because you’re more likely to experience a one-off unexpected expense than an unexpected life-changing event.
How much money should I save in my rainy day fund and emergency fund?
The amount you should dedicate to both funds depends on your specific situation, for instance, if you have a car that’s prone to breakdowns, you’re more likely to need to spend money on repairs and therefore require a larger rainy day fund compared to someone with a reliable car. We recommend saving anywhere between £500 and £2000 for your rainy day fund.
We recommend saving anywhere between 3 months to a year’s worth of living expenses for your emergency savings fund. As a general rule of thumb, if you have multiple income streams, a stable job and low outgoings, you should aim to save at least 3 months worth of expenses. If you have one income stream, an unstable job and high outgoings, you should aim to save at least 6 months worth of outgoings. For example, if you’re a one-person household with one income stream, you should aim to save at least 6 months worth of expenses, because a job layoff will lead to a 100% reduction in your household income. Assess your financial situation and determine how much money you need to save in each fund.
Savings Tips
We recommend treating your savings like a bill by putting money aside each month and including it in your monthly budget. If you pay your bills via direct debit, it’s a good idea to automate your savings, by setting up a standing order. Lastly, it’s very important that you keep this money in a separate account or pot to your everyday spending so it’s easier to manage.
Even if you can only save £1 a month, save that! Saving a small amount of money is still better than saving nothing at all and it helps you develop a savings habit. You could complete a money savings challenge to help you build your funds. The 1p Savings Challenge is a great savings challenge for beginner savers. It’s a yearlong challenge which looks at the day number of the year and saves that amount in pennies. On the first day of the challenge, you save 1p, and then 2p on the second day, and eventually £3.65 on the last day. This adds up to £667.95 at the end of the year!
Are you going to build a rainy-day fund and an emergency fund? Let us know in the comments below.