When someone yells "emergency," everyone hopes a nurse is nearby to hear the call. Who else knows the appropriate first-aid measures and can stay calm under pressure? Thanks to extensive education and training, nurses are adequately prepared to deal with an unexpected medical crisis.
But how many nurses are adequately prepared to deal with an unexpected financial crisis? Problems, after all, come in all sizes and shapes: a leaky roof in need of replacement, a hurricane that leaves your property in critical condition, a sputtering car demanding repair, an unexpected job loss, an illness or injury. Extra cash can ease the burden during a crisis, especially if that cash is a "rainy day fund"-an account into which money is funneled during the good times to prepare for the unexpected bad times.
Building a shelter for your funds
The first step in building your umbrella of protection is determining how much money you'll need. Most financial advisors recommend having three to six months of living expenses as a starting point for adequate coverage. If you aren't sure how much that amounts to, it's time you found out. After all, the secret to financial peace of mind lies in knowing how much is going out so you can have enough coming in.
For one month, keep a diary of every cash purchase you make and every bill you pay. Include all purchases, no matter how small-latte from Starbucks, chewing gum, lotto tickets. Don't forget to include the fun things, too, like going to the movies and eating out. If the money leaves your pocket, so should your notepad. Write it down. At the end of the month, add up your expenses. This gives you the monthly figure you'll need to build your emergency fund. Multiply it by six, and voila: You have the total amount you need to sock away.
If you're not the diary type, use your net monthly salary as your base figure. If, however, you have a tendency to spend more than you earn or wallow in credit card debt, you won't get an authentic sense of how much money you need to support your current lifestyle.
Drops in the bucket
Build up your rainy day fund gradually. Overcome the tendency to perceive saving additional money as an overwhelming task or impossible dream. Saving a little bit each week is child's play compared to the thousands of dollars you might be called upon to cough up during an emergency. Try saving $20 a week. That may seem like a drop in the bucket, but by the end of a year you'll have a bucketful-$1,040, not including any interest earned. That's a nice healthy start.
Types of rainy day accounts
Now that you're committed to having an emergency fund, choose an appropriate place to stash the cash. There are two main rules governing account selection:
Keep your money in an account that's liquid so it's easily accessible when you're getting drenched with expenses.
Don't take risks with that money. (That's what investing is for.)
Avoid investing your rainy day fund in the stock market. You don't want to be in the position of needing the money during a bear market (a 20-30 percent decline), when your rainy day fund could look like a sad little puddle.
You could, of course, keep the money in a cookie jar, but why do that when your money can earn sweet returns? The following types of accounts are secure and they pay interest:
Savings account
A traditional savings account at a bank is one of the safest places to keep your rainy day fund. You can withdraw the money instantly with no penalties, and there will be no loss of interest or principal upon withdrawal. Usually, no minimum balance is required to maintain the account. What's more, the FDIC (Federal Deposit Insurance Corporation) will usually insure it for up to $100,000. The drawback? Interest payments are a tiny drizzle.
Money market account
Generally offered by banks, a money market account usually requires a minimum balance. Because of its liquidity, it is an excellent place for emergency funds. Some banks, however, limit the number of checks you can write each month. Plus, if you withdraw funds and your account balance drops below the minimum, there may be a penalty or service charge. A bank money market account generally is FDIC insured.
Money market fund
Generally offered by brokerage houses and mutual fund companies, a money market fund is liquid and invests in short-term obligations issued by corporations, certificates of deposit, and government securities. Most money market funds offer check-writing privileges. Your funds are pretty safe in a money market fund, but accounts are not FDIC insured. The Securities Investor Protection Corporation (SIPC), however, insures money up to $100,000.
Certificates of deposit (CD)
When you purchase a certificate of deposit (CD), you plunk down your money for a set period of time with a guaranteed amount of interest paid at regular intervals. Interest rates are generally higher than in traditional savings and money market accounts. The FDIC insures bank CDs, but if you withdraw your funds before the agreed-upon date, you may be penalized. Therefore, even though interest rates are higher, CDs are not the best place for your emergency funds.
Just say no!
Resist the temptation to use your emergency funds for other purposes. While it may seem convenient to dip into your account to borrow $1,200 for that new living room set, don't! If you can anticipate the need, you can develop a budget to meet the need. If you want a new living room set, make room in your budget to save for it. A rainy day fund is to be used for emergencies only.
Also say no to the use of credit cards for rainy day coverage. The interest payments may well be more costly than the emergency itself.
Let a smile be your umbrella
A rainy day fund can help reduce the pain of dealing with an emergency. By knowing there's enough money to support you through a crisis, your mind will be clear to focus on the important things. Just remember: Once you use your rainy day fund, replenish it as quickly and efficiently as possible. It served you well; now prepare it for its next mission. Even the best meteorologist can fail to predict a downpour.
