By Dustin Giannangelo
CEO Fusion Wealth Management
A rainy-day fund is a specific amount of funds set aside in case of an event that could cause a personal financial dilemma. There are many instances in life when a person requires a rainy-day fund. Specific examples such as a health crisis, home repair, or loss of a job, make having an emergency fund critical to have.
Many people know the importance of having a rainy-day fund for such occasions, yet those that are starting to save for an emergency fund are unsure of the right amount to have safely tucked away.
The best way to accomplish any long-term goal is to segment out the steps to achieve it. As the saying goes, “when eating an elephant, take one bite at a time.” Many people become paralyzed by the magnitude of starting something, but the ability to segment out those steps can empower them to accomplish their long-term goal.
Therefore, let’s take some time to understand what the right amount of money is to have set aside for your rainy-day fund.
Many blanket statements claim that there is a perfect amount of money to be set aside for an emergency fund such as three months or six months of hard bills. We think using such a broad-based statement does not drive the point home when people are beginning to think about setting up an emergency fund.
Our answer, fingerspitzengefühl.
There is no exact translation for this German word, but it translates to a fingertip feeling. Only you know the exact inflows and outflows of your family’s finances. You can determine at an emotional level what amount of money needs to be set aside that would allow you and your family to sleep comfortably at night.
For those who feel like they lack fingerspitzengefühl when it comes to their finances, we use a simple formula to help people understand what the right amount is for them.
Monthly expenses are the minimum essentials to continue your lifestyle. It should include your fixed bills and the main essentials such as food, loan payments, transportation, housing, and health insurance, etc. Once you add up all of your monthly expenses, you should have a solid grasp of the amount needed to cover your lifestyle each month.
The unemployment period is essential to know since most people’s primary source of income is through their work. According to the Bureau of Labor Statistics, the average duration of unemployment is 25 weeks. You can make this part of the formula more specific by customizing it to one’s industry and occupation.
While we know that there are many other circumstances for leaving a role outside of losing a job, such as a personal or medical leave of absence, most people feel that a sudden job loss would cause the most significant risk to their lifestyle.
Now that you know the best way to calculate the amount needed for your rainy-day fund we can turn our attention to five of the most effective means for accumulating it.
Many people find themselves with loose change or a few extra dollars at the end of the day. Usually, this comes from getting paid back in cash for getting a co-worker’s coffee, or friends giving you money when splitting lunch, etc. Most of us find that those extra dollars don’t last long in our pocketbook and we usually make an impulse purchase with them.
If you dedicate removing and saving that loose change each evening, it can quickly accumulate towards your long-term goal of having a rainy-day fund. For instance, if you acquire just ten dollars a week in extra change, you could have 520 dollars by the end of the year.
Automated micro deposits into your savings account can help accumulate towards a long-term savings goals to establish an emergency fund. For instance, if you removed the expensive cup of coffee every day and set aside$5each weekday going automatically into your emergency account, you will have 1,300 dollars saved up by the end of the year.
Imagine if you increase the amount saved to $12 every weekday. By the end of the year, you will have accumulated over $3,000. Everyone’s financial situation is unique, but applying the principle of the micro-deposits, you can quickly be on your way to amassing a substantial emergency fund.
Saving money for emergency purposes is not as easy as it is perceived. An excellent strategy is to take your tax refund and immediately put it into your rainy-day account. Your tax refund can be a useful injection of capital for your emergency fund each year.
Spending your way through your tax refund is easy. If you have extra money inside your checking account, you may be very tempted to make frivolous purchases. To avoid this situation, work with your tax professional to have the refund sent directly to your emergency fund account. This way it is not as easy to spend the money by not allowing it to go into your checking account. It should help remove the temptation of making a significant purchase with the tax refund.
As you evaluate your monthly cash flow situation to find ways to save for a rainy-day fund you may find yourself with extra income as you finish paying a debt. Once you finish paying off liability for a car loan, a student loan, or a credit card use the now extra cash you were paying toward the debt to pay towards your rainy-day fund. You are already used to the lifestyle by living on less with that original debt payment, so this should make it easy. Now that you are redirecting the new monies into your emergency fund, it will help you build it much quicker.
As you think about your monthly expenses, make a distinction between what is a necessity in your life is and what you can cut out of your spending. Expensive dinners are the easiest way to cut back, and for a fraction of the cost, you can prepare a meal at home. No longer is it acceptable to spend $50 on dinner when you can make an excellent one for $10.
Insurance costs can be one of the handiest ways of saving a significant amount on your fixed bills. In fact, insurance discounts may be one of the least hassle-free means of saving money for a long-term goal, such as creating a rainy-day fund.
In that regards, you should speak to an independent insurance agent in this context. Insurance agents who operate independently can help you save money since they do not work with only one insurance carrier. They have a vast network of insurers that they can use to find the best-priced deals for you. Naturally, they may be able to uncover better coverage for less cost.
You now know the five most effective ways to save for your rainy-day fund, and we can shift our attention towards how to best protect your funds from eroding over time.
Many people believe that having a rainy-day fund in a savings account or a “risk-free” vehicle is entirely safe. Why? They claim that there is no chance of loss of principal and you can gain access to it immediately. However, they forget about one thing, inflation.
If you take inflation into account, there is a significant chance that the money you save will not come back out in the same real dollars. With interest rates for cash staying significantly low there is a high likelihood that your actual return for your rainy-day fund will underperform in the coming years. It also means that you will have a substantial portion of your wealth not growing for an extended period and it will be losing its buying power each year.
As you come to decide what the correct amount of money is that you should have in your rainy-day fund, you should also consider the number of investable assets you have. However, most people ignore this critical piece of information.
Here is the truth, if your investable assets are five times above your emergency fund’s value, you eliminate the need for a rainy-day fund.
Above the five times threshold, you can afford to withstand a significant market loss, still have enough money to cover monthly expenses, and find your next job, should you ever need to tap into your emergency fund.
We know this seems like a very bold statement so let’s examine a worst-case scenario.
Imagine that you have calculated needing$30,000 for an emergency fund using the formula:
Monthly Expenses x Unemployment Period = Rainy Day Fund.
At the same time, five times your emergency fund is $150,000. Let’s say you invested that in a conservative cash alternative vehicle to keep pace with inflation and aimed to have a small amount of appreciation each year. Next, assume you invested at the peak of the bond market and saw the worst crash for US Treasuries over the last 38 years which was in 1980 and you were immediately down 16%. That means your investment would have declined to $126,000.
($150,000 x (1-16%)) = $126,000
Assume the worst case is that you take your emergency fund at the bottom of the bond market. If this is the case, you still will not have withdrawn 25% of your overall investable assets.
As painful as it would be to sell at such a time with very depressed values, you see that having a large chunk of cash on the sidelines forever does not always make sense. While looking for ways to enhance your rainy-day fund to fit your situation, it is worth considering if you have a considerable sum of investable assets that could be used to substitute your fund.
Ultimately, having a rainy-day fund set aside in case of an event that would cause a financial nightmare is one of the most critical fiscal strategies you can have.
If you implement these steps to save, protect from inflation, and leverage your investable assets, you will be on a precise path to creating a rainy-day fund, and you can rest assured knowing that you have built peace of mind for yourself and your family.
Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Fusion Wealth Management, LLC is not affiliated with Kestra IS or Kestra AS. Kestra IS and Kestra AS do not provide tax or legal advice and are not Certified Public Accounting (CPA) firms. FINRA's BrokerCheck