100 Words On: Why You Need Emergency Savings AND a Rainy Day Fund

People often use the terms “rainy day fund” and “emergency savings” interchangeably when they are really two completely different forms of personal finance insurance. A rainy day fund is meant to help you weather short-term, relatively low-impact financial storms of less than $2000 such as a major car repair. On the other hand, an emergency savings account with three to six months of living expenses is designed for longer-term crises such as a job loss or medical issues.

The bottom line: Keeping dual emergency funds provides a rock solid hedge against the unexpected to help ensure you stay in control of your life.

Photo Credit: striatic

19 comments to 100 Words On: Why You Need Emergency Savings AND a Rainy Day Fund

  • Sharon

    That’s a smart idea. I’m just starting to build up my savings. Which one should I build up first?

  • Len Penzo

    Good question! Concentrate on building the smaller one first, Sharon.

  • Chupacabras

    It’s not a bad idea to put the emergency savings in T-Bonds while leaving the rainy day fund in a more conventional account (CD’s, high yield checking, money market fund, etc.). That way you can protect that big chunk of liquid money from inflation as well as your own grubby fingers.

    It’s also not a bad idea to use a Roth for the rainy day fund, so long as you qualify and weren’t already contributing to it. If you need the money, it’s there and if you don’t, it’s tax sheltered and building in value. I still think treasury bonds are a better way to do this, but it’s a really good idea to get as much money squirreled into a Roth as you can since the annual contribution limits are so low.

    But that’s more than 100 words.

    • Chupacabras

      Err, Roth for the emergency fund, not the rainy day fund.

      • Len Penzo

        It may be more than 100 words, but it’s very good advice — and much appreciated! The main purpose of these 100 word posts is to stimulate discussion, and I often depend on your inputs to help fill in the holes that sometime result from my self-imposed word constraint. :-)

        I think a lot of people overlook the fact that they can use their Roth as their de facto emergency fund. I recently read a nice article at the Oblivious Investor that advocated the same idea. In fact, that piece suggested there is no reason to have a large cash emergency fund once the Roth is built up to a significant level.

        • Chupacabras

          I just went over and read his article. Definitely makes some good points and I guess if you aren’t using it for retirement planning or use it for safe-ish investments it could work.

          Mine’s almost entirely small cap tilts that round out my over-conservative 401 plan. Selling some of those investments if the market’s taken a downturn could do some nasty damage.

          In the end, the lesson’s to always tax-shelter your money when you can!

  • Although I have savings, I choose to put the funds to work. I can handle less than a $2,000 surprise.

  • Michelle

    Great advice!

  • Chupacabras touched on the reason I don’t keep my emergency fund in investments. Last thing I need during an emergency is to be furthered stress about having to sell at the wrong time.

    Ideally, your emergency fund should be in addition to your maxed out tax advantaged investments. If you can not afford to do this, you probably can’t afford to take the risk that your emergency will happen at a market low.

    • Len Penzo

      Absolutely, Cassie. I know I wouldn’t use a Roth as my de facto emergency fund unless I had a significant amount of money in it that could withstand a 60 percent loss overnight AND still leave me with 6 months of living expenses. Once one gets to that point, however, the advantages of putting those emergency funds into a Roth become intriguing.

  • tim

    If the Roth investments were conservative until 6 month living expenses were accumulated and then future contributions went to more rewarding investments, I think the argument for the Roth as emergency fund may be good. I think conservative 401k and conservative Roth may cost some performance (depending on time horizon), but I am not sure which would be better to house more aggressive investments. The argument against a Roth would be relying on the promise by the government not to tax earnings 30 years from now.

    • Len Penzo

      You’re right, Tim. It is definitely something to think about. Those who believe the government won’t/can’t renege on their promise to not tax Roth withdrawals are only kidding themselves.

  • Jared

    I had a job loss about one year ago, and found my savings account fully ready for 7 months of unemployment, thanks to the economy. An emergency fund, as Dave Ramsey recommends, would have had me on the streets. His way only works if you can FULLY pay off the loan.

    I condone a 1) short term and 2) medium term emergency fund. That way, you’re able to be better prepared for the worst case scenario.

  • Pichirino

    Agreed that an emergency fund is highly required for life’s storms,but for those who have both a job which cannot easily be lost(government) and great healthcare coverage could the same be needed?

    I take the bus to work so a broken down car is quite unlikely.

    What longterm crisis would I get to need a 3-6 months emergency fund?

    of note.I have such a fund,just don’t know why exactly.

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