If you lost your job tomorrow, would you have enough money to pay your bills without running up credit card debt? What if your car broke down and you needed $3,000 to get back on the road? Could you come up with the cash?
If you answered "no," then you need to create a rainy day fund, dollars that you can tap in case of a financial emergency. The benefit of such a fund is obvious: If you have one, you will not need to go into debt to handle the monetary emergencies that so frequently pop up.
U.S. consumers not ready for emergencies
If you do not have a rainy day fund, you are far from unusual. According to Bankrate.com's June 2014 Financial Security Index, 26 percent of U.S. residents have no money set aside for financial emergencies.
Those that are saving have probably not saved enough. The Bankrate.com survey reports that 24 percent of respondents have less than three months’ expenses saved, and 17 percent with three to five months. Only 23 percent of the respondents had saved enough to cover six or more months of expenses.
How would consumers that had not adequately saved cover emergency expenses? Many would borrow from family members or friends while others say they would neglect a different financial obligation. Others would, of course, put the debt on their credit cards.
None of these are reliable options. The best bet is to have an emergency fund available. The good news? Starting an emergency fund is not overly complicated.
How much do you need?
First, you have to determine how much money you need in your rainy day fund. Most experts recommend that you have at least enough money in your emergency fund to cover three to six months of expenses. However, depending on the state of the economy or stability of employing within your profession, you might need more or less. Of course, the more money you have, the better. That is especially true in today's economy when it is still very easy to lose your job and quite difficult to find a replacement.
To determine how much money you need, take a long look at your monthly expenses, including everything from your recurring bills -- such as your mortgage payment, car bill and student loan payment. Then include those expenses that vary from month to month -- everything from your grocery bills to your utilities and minimum monthly credit card payments. Add these and then multiply them by the number of months you want to cover.
If your monthly living expenses come out to $4,000, then you'd need $12,000 for three months of emergency funds or $24,000 for six.
That is just the start of your rainy day fund. You'll also need to budget savings for emergency situations. What if your kitchen sink suddenly springs a leak and destroys the cabinet underneath it? What if your car needs a new transmission? What if you need medical care and your insurance only covers part of the procedure? These are all financial situations that could throw you deep into debt without an emergency fund.
It is hard to estimate how much you'll need for these emergencies. Real estate company Coldwell Banker, for instance, estimates that it usually costs 1.5 percent to 4 percent of a home's purchase price for maintenance every year. It could cost about $900 a year on average to maintain and repair a car that is five years or older. To be on the safe side, then, you might need to boost that $24,000 emergency fund to at least $30,000.
That amount might seem like an overwhelming sum of money to save. However, it is not.
No one expects you to save your money immediately. You'll have to build your emergency fund over time. Start putting away whatever you can each month. This might mean cutting down on unnecessary expenses such as eating out, going to the movies or buying that high-cost coffee on your morning commute.
It also helps to set up a direct deposit from your regular paycheck into the account that is holding your rainy day funds. Saving money is easier when you do not think about the money you are stowing away. With direct deposit, you never miss the money you are saving.
Where to save it
Experts recommend that you save your emergency fund dollars in an interest-bearing bank savings account.
There is a reason for that: You want to have easy access to the dollars in case of an emergency. With a savings account, you'll be able to tap your savings quickly. Moreover, if you have your dollars in an interest-bearing account, you'll at least earn a bit of money. You will not get rich, certainly, by having those dollars in a traditional savings account. However, you'll make a bit of extra cash.
Many financial experts recommend that you start you rainy day fund before you take on other significant financial tasks such as paying off high-interest rate debt. That is because a financial emergency, if you do not have the cushion of an emergency fund, could throw your financials into chaos. If that occurs, an emergency could send your high-interest-rate debt soaring to new heights.
If you want to get financially healthy, the message is clear: It is time for you to make a commitment to a rainy day fund of your own.
© Fintactix, LLC 2015