There are several types of financial instruments that can help you guard against unexpected problems. Having reserve funds is just part of that equation. These funds are meant to help you get over a financial crisis that would usually impact your main source of income. It can also help you guard your household budget against sudden unscheduled expense.
There are basically two types of this saving fund, an emergency fund and a rainy day fund. There are a lot of consumers who are confused between the two and usually mix up one with the other. For some, they believe they are actually one and the same.
But as important as reserve funds are, not all people are saving for the unexpected. As Statisticbrain.com shares, there are only about 38% of American consumers with an emergency fund tucked away for the future. Some may have rainy day funds but with the confusion, they either refer to their emergency fund as their rainy day fund or think that their savings will work the same way as a rainy day money.
Apart from being responsible in using emergency fund, people need to know how to differentiate it from a rainy day fund. Both of these are necessary if you want to keep your financial life secure and protected against the unforeseen expenses. It is hard to control all aspects of your financial plans because there will always be external forces that can have a big effect on your planning efforts. What you can do is to just be prepared for whatever can happen.
Differentiating the two saving funds
An emergency fund and a rainy day fund are two types of reserve funds that you need to understand to prevent overlap of use. Here are the main differentiators between the two.
- Emergency fund. This is the more popular between the two types of saving funds. This is because a lot of financial experts have advised time and again that consumers need to have this to secure their budget and deal with financial emergency. Any unforeseen and unprepared financial crisis can topple down your budget in an instant and having an emergency fund is what keeps your finances from crumbling down. This is usually meant for big emergencies such as losing a job or an illness that sometimes entail a medical operation. As such, an emergency fund is measured by how much you spend in a given month. There are a lot of people suggesting that this should be about six months worth of expenses because this is the average amount of time people spend looking for a new job.
- Rainy day fund. Apart from big emergencies, there are are small ones that can happen in between and using your emergency fund seems counter-productive. This is where the second type of reserve funds come in to the picture. It is supposed to tackle small financial emergencies to separate it and keep your emergency fund intact. This can be anywhere from a broken home equipment, minor home repairs and sometimes even a plane ticket to see a sick relative. With the nature of what it covers, a rainy day fund is usually smaller compared to an emergency fund. It usually anywhere from $1000 to a few week’s worth of expenses.
Why you want to have an emergency fund in your budget
Here is a short video on how to get started with an emergency fund.
Some people would be quick to point out that earning a lot is enough to offset any unexpected financial needs and they question the need to have reserve funds. Having a nice big income will surely help but the work does not end there. If you do have a big income but use them at your heart’s content, chances are you will be in debt after just a small crisis. Here are a few things to remember to convince you about the importance of this funds.
- Preserves your money. USNews.com shared that the average savings of a household is at $12,000 – at least for those headed by a 55-64 year old. The scary part is that if they do not have any type of reserve funds to speak of, their savings and probably even their retirement money would go down the drain just to cover an important expense. Having an emergency fund and a rainy day fund helps you keep your finances intact and prevents you from falling into debt.
- Secures your emergency fund for real emergencies. This has to do with having both an emergency fund and rainy day fund. If you only have an emergency fund and you encounter small emergencies often, chances are your emergency fund will be depleted real easily. And as people have come to realize that emergencies come when you least expect them to, getting caught in a financial emergency with your fund depleted can be really challenging. Having a separate fund to address the smaller needs keeps your emergency fund in tact to address the bigger emergencies.
- Helps you categorize the unexpected expenses. If you can’t stay on budget because you keep on mixing up the funds and what they need to be for, having two reserve funds will help. It can help you separate the money for trivial home repairs or even a blown out transmission from the more important ones like losing a job. It puts more structure with the way you lay out your monthly household budget.
Ways you can keep yourself from spending your savings unnecessarily
Having a fund for emergency situations is not the end of it but is actually just the beginning of maintaining your finances and keeping them in order. You need to make sure that they are used for their intended purpose. Here are two tips to help you with the proper way to use reserve funds.
- Set clear restrictions and definitions to what an emergency is. An emergency can be encompassing as it can cover anywhere from a busted light bulb to getting laid off. One way to make sure that use the funds accordingly is to set clear parameters on your definition of an emergency. Understand what incidents would compel you to use your emergency fund and what would be categorized under your rainy day fund.
- Make it harder to access your emergency fund. This is quite tricky because your reserve funds needs to be accessible and within arm’s reach in case emergency strikes. But it does not mean that you keep them in an envelope with rubber bands with one under your bed and the other under the couch. You can look at putting them in a checking account or a savings account. This way, your reserve funds can earn a little interest while being accessible at a distance. This can help you think twice before you use the money in frivolous expenses. You can also invest them but make sure it is an investment that can be easily liquidated and will not take weeks to access.
- Keep communication lines open. This applies specifically for couples who are sharing the same budget under one roof. This is another layer of security that can help consumers think twice before spending the reserve funds. They need to talk to their partner and it has to be a mutual decision when using either the emergency fund or the rainy day fund to address any financial need. This way, two sets of eyes are looking at details that lessens the margin of error and increases the chances of looking for alternatives before dipping into the reserve fund.
Reserve funds are great financial support to help you keep your budget in tact. You just need to understand the different types and how to use them accordingly.