ONE OF THE MAIN REASONS we save is for peace of mind in being able to support ourselves and our family in the face of setbacks like job loss, ill health or a debilitating accident. It is recommended that we save at least three months’ living expenses as a rainy day fund and set those funds aside to deal with emergencies.
Living expenses consist of the typical cash payments required on a monthly basis, such as mortgage or rent, food, transportation cost, utilities, entertainment, groceries, and so on. Living expenses is the average amount of cash you need to meet a month of living.
For homes in which there is only one breadwinner, the rainy day fund should best be even bigger, say, at least five months’. It is easy to be daunted by the size of the fund at the beginning of setting it up. However, even with relatively small amounts of savings, provided that funds are set aside regularly, eventually the rainy day fund will be established.
The rainy day saver also has to be disciplined enough not to spend from the fund except for real emergencies.
Having proudly reached your target fund, avoid thoughts of, say, buying a new car or taking an elaborate vacation. This fund is for emergencies only, held as a precaution against major setbacks.
Another consideration in establishing a rainy day fund is where to hold it. It is recommended that the funds be held in a low-risk, high-interest account.
The fund should also be readily accessible in cash. Here are four alternatives for holding these funds:
(1) Deposit the funds in a credit union account. Most credit unions pay higher interest on deposits than banks on ordinary saving accounts. Should an emergency arise, the funds can be accessed right away.
(2) Purchase Government saving bonds. These investment instruments are typically available to the public on a quarterly basis through a commercial bank. You can ask your bank manager to alert you whenever there is an issue of these bonds, giving an idea of how much you plan to purchase. Here, too, the interest rate on Government saving bonds tends to be higher than that of a bank account.Another attractive feature of Government saving bonds is that they can be purchase in different denominations – $50, $100, $500, $1000 and $5000. This provides flexibility in being able to convert bonds in the denomination(s) needed for an emergency without having to cash in the entire fund.
(3) When the fund is more substantial, it may be possible to negotiate a term deposit with a commercial bank at a slightly higher interest rate than the ordinary saving account. However, if an emergency occurs within the term period of the deposit, you may be forced to break the deposit and lose part or all of the accumulated interest depending on the terms of the deposit.
(4) The accumulated fund could also be placed in a money-market deposit account. Such an account typically has a minimum deposit of, say, $5000 and pays a higher interest rate than a normal deposit account. It is possible to access funds as needed with little or no penalty.
Once established, a rainy day fund increases one’s financial confidence.
• Louise Fairsave is a personal financial management advisor, providing practical advice on money and estate matters. Her advice is general in nature; readers should seek advice about their specific circumstances.