You've heard the expression "saving for a rainy day," but what does it mean in the post-Great Recession era? While it has always been smart to put aside money to counter the unexpected, it's even smarter to do so with a purpose. A casual approach to saving isn't enough. Today, the so-called rainy day fund isn't about saving for a single rainy day; it's about saving for at least 240 of them.
What is an Emergency Fund?
Financial gurus have long championed a three-to-six month emergency fund with some, such as Suze Orman, now advocating an eight-month emergency fund. What do they mean by "emergency" fund? They're not necessarily talking about medical emergencies, though sometimes those will trigger a need to dip into these funds; they're talking about financial emergencies.
For example, if you lose your job, an emergency fund serves as a financial buffer and covers your basic living expenses for the number of months you have funded. In the past, three-to-six months was considered a sufficient amount of time to find a new job. The sluggish recovery and high unemployment numbers have made it more difficult and time-consuming to find work, thus the recommendation for an eight-month emergency fund.
Determining How Much You Need to Save
To determine the amount of money you need to put aside, add up your basic monthly living expenses and then multiply that number times eight. Make sure to include all of the necessities such as your house payment, insurance, taxes, car payment, utilities, food, medicine, and so on.
In addition to your regular monthly expenses, find out exactly how much your health insurance actually costs. If you lose your job, you'll also lose your employer's portion of your health insurance costs. Not only will you have lost your income, your health insurance costs will go up – potentially dramatically. According to the Kaiser Family Foundation's 2011 Employer Health Benefits report, the average annual cost of employer-sponsored health insurance for family coverage was over $15,000 in 2011. If your employer pays most of your health insurance premiums and you lose your job, your monthly expenses could increase by over $1,000 each month.
Once you have a monthly figure for your necessities, create a separate list of monthly expenses that you could eliminate in a financial emergency such as eating out at restaurants, cable television, satellite radio, streaming movie service, 4G access for your iPad, vacations, gifts, and so on.
How to Fund Your Emergency Fund
Now that you've added up your basic living expenses and multiplied them times eight, you have a figure to work with. Granted, it's probably quite large. 240 days of living isn't cheap, is it? For example, if your monthly expenses are $4,000 per month, you'll need $32,000 to survive eight months of unemployment, disability, or some other financial catastrophe. While the dollar figure may be intimidating, you at least have a goal and can now begin saving with a purpose.
Start by assessing your current savings. If you have funds in a Roth IRA, you could consider those funds as part of your emergency fund as you can withdraw your original contributions from a ROTH IRA without penalty if needed. Do you have other savings accounts that you can draw from? Whether you do or not, open a savings account specifically for your emergency fund and start funding it. The act of opening a separate bank account for your emergency savings is vital. Set up automatic transfers each month from your checking account to your emergency fund immediately upon opening it and consider this fund untouchable. Do not dip into it for a vacation, holiday gifts, or a new car.
Once your account is set up, prioritize funding it. Remember that list of monthly expenses you could live without in an emergency? Consider cutting those costs now and putting the savings into your fund. Get the family involved in saving money, and you will likely find creative ways to slash costs and have fun at the same time. Other ways to build your fund include:
• Selling stuff you no longer need
• Finding out if you can eliminate PMI on your mortgage
• Using coupons
• Living more frugally
• Getting a part-time job
• Learning to say no to fundraisers
• Creating a budget
• Eliminating duplicate services such as your landline if you have a cell phone
• Raising your insurance deductibles
• Refinancing to a lower interest rate (if it makes sense)
• Paying off high interest credit cards
• Using less energy
• Driving less
• Stopping restaurant dining
• Cooking from scratch
• Eliminating a bad habit
• Canceling memberships and subscriptions you don't use
• Waiting at least 72 hours before making an "impulse" purchase (you may realize you don't want or need it after all)
• Depositing any tax refunds, raises, rebates, or other windfalls into your savings account
• Getting rid of credit cards. Keep one for emergencies, but don't keep it in your wallet. Instead, place it in your safe or even freeze it in a block of water in your freezer.
• When you pay off a loan, take that amount and pay your emergency fund each month
• Shopping with a list, and stick to it
• Extending the time between hair appointments by a week or two (or three)
• Finding less expensive entertainment options such as picnics, hikes, and free concerts
Saving for 240 rainy days may seem impossible, especially when you're looking at a goal of saving tens of thousands of dollars. However, with each dollar you put into your fund, your financially security becomes that much stronger. As your fund grows, you will become more confident. You don't have to save it all overnight, but you should save with a purpose. Make putting money into your emergency fund a priority and you will likely discover that every penny adds up. By the time you reach your goal, not only will you have a healthy emergency savings fund, you will have learned to be fiscally responsible. Your accomplishment will serve you well both in times of need and in other areas of your financial life.