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What is a Rainy Day Fund?

A rainy day fund is a distinct account that helps you handle the occasional financial shocks that life throws your way. It’s a useful tool for smoothing out those rocky financial periods and cutting down on the need to tap more expensive cash avenues like credit cards. A rainy day fund ranks above creating an emergency savings account and paying down debt in terms of importance to your financial health.

There’s a lot of advice out there about how to manage your money. Much of it is common sense: avoid excessive spending at coffee shops and bars, save where you can, live within your means and splurge on occasion only when it makes financial sense to do so. But it can be easy to overlook the importance of planning for the unexpected expenses that life is bound to throw your way. That’s why it pays to have a little bit of a cushion.

The definition of a rainy day What is a rainy day fund? fund differs slightly from that of an emergency fund. Rainy day funds are meant to cover random mid-sized costs that might not fit into your monthly budget — things like flat tires or unplanned trips to the dentist. Emergency funds, on the other hand, are intended for bigger emergencies and financial calamities. These might include sudden job loss, large medical bills that exceed your insurance deductible or major car or home repairs.

It’s generally recommended that you build up a rainy day fund to a level equal to about six months worth of living expenses. However, that number will vary depending on your own unique situation and the size of your household. You can figure out the right amount to save by listing all the little things that could go wrong in your daily life and then estimating how much it would cost to cover them, such as a replacement refrigerator or water heater. You can also think about seasonality and factor in the potential for extra expenses related to back-to-school shopping, holiday spending or family vacations.

A rainy day fund can be stored in a variety of ways, but a high-yield savings account might be the best option for you. This type of account offers the accessibility and liquidity of a regular savings account but earns higher annual percentage yields than traditional savings accounts do. It can also be accessed quickly via online banking or mobile apps if necessary.

Ideally, you’ll keep your rainy day funds separate from other savings accounts and spending cash, so that you’re less likely to dip into them for discretionary purposes. It’s also helpful to set up automatic transfers to your rainy day account each month so that you can gradually build up the cushion without giving yourself a false sense of security.

Then, when it comes time to use the money, you can do so without having to pay any taxes or penalties if the withdrawal is an emergency. It’s a much better alternative to tapping into your retirement accounts, which can carry income tax and a 10% early withdrawal penalty.

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