The Importance of a Rainy Day Fund

So you have a budget, a savings plan, fully paid bills every month, an emergency fund - hallmarks of a healthy financial life. But what about your rainy day fund?

Think about all the things that you don't plan for. What if a family pet gets sick and requires treatment from the vet? Or Ol' Reliable, your 20 year old Buick, suddenly isn't so reliable and breaks down. Even worse, your laptop suddenly crashes as you're getting everything together for that all-hands-on-deck Zoom meeting tomorrow morning.

What do you do? You may have your budget prepared for the month, but none of these expenses were part of the plan. Where are you going to pull the money from for these surprise bills when you've budgeted everything else apart from them?

In comes the rainy day fund.

In this article, we'll delve deeper into this critical piece of financial security: what it is, why it's important, and how to build one of your own.

Break out the umbrella!

What Is a Rainy Day Fund?

A rainy day fund is a pool of money designated for one-off expenses that aren't part of your daily budget. It's a separate budget for big expenses that you can plan for, without necessarily knowing when you'll need to spend them. Think of it as your savings account for surprise splurges!

Even though it seems similar, a rainy day fund has a different purpose than your emergency fund or savings! Your emergency funds are meant to carry you through unexpected events, typically long periods of time without an income as the result of a job loss, an economic fallout, or a pandemic. On the other hand, your savings are meant to (ideally!) remain untouched until you break it out for a big purchase like a house.

The pandemic has revealed the importance of these funds like no other time before. With many affected by layoffs, furloughs, and long periods of unemployment, Canadians are collectively seeing the importance of six months' worth of a financial safety net - or more.

Pandemic life expenses have become more common, too. With the mandate to work and attend school from home, for example, we're spending more on home office supplies, furniture, and tech setups. More child care might be called for. In scenarios like these, a rainy day fund comes in handy.

What Happens if You Don't Have a Rainy Day Fund?

Nothing throws your budget out of whack like an unplanned appliance replacement or an urgent trip to the vet. Without a rainy day fund, these occasions can throw a major wrench in your budgeting efforts. In worst cases, they force you to rely on your credit card or take out a loan.

For anybody who has used a credit card, you've probably seen at one point the cost of using it (if you aren't using it in a smart way!) can be more expensive than the money you're even using. Credit card and payday loans have high interest rates; they're there if you absolutely need them, but if you don't have money set aside to repay them in full, these debts grow. Unwittingly, without a rainy day fund, unexpected expenses could end up being more expensive as you rely on these methods for the missing cash.

Having a rainy day fund is part of good financial planning. It gives you peace of mind, because you know that if anything comes up, you'll be able to cover it financially.

Consider it the opposite of a vacation fund. Vacations are a luxury we all look forward to spending money on. Meanwhile, nobody looks forward to a rainy day - but they occur, and covering them is a necessity. What you want is to be able to afford both - a holiday in the Maldives and a roof that finally stops leaking.

How to Start Your Rainy Day Fund

It's tough to know how to start planning your rainy day fund, especially when financial recovery due to pandemic repercussions is still a long ways off for some.

While general emergency funds are to keep you afloat for three to six months, rainy day funds are a little more specific and a lot smaller. This is why it's great to start with your rainy day fund instead of your emergency fund. Since it's less money, you can get that financial win faster. It'll inspire you to  keep moving forward and making that emergency fund!

The reason they're more affordable is because they don't need to sustain you for months - your rainy day fund is meant for one-off events.

"I call these events the 'expected unexpected', or the 'unexpected expected'. It kind of works both ways because you know that they're going to come up," says Shay Steacy, head financial planner and principal at Kind Wealth, an advice-only financial planning firm. "You know that if you own a car, at some point you're going to have to get snow tires, or fix something. You just don't know when it is."

To create your rainy day fund, start with a personal assessment. Do you have a partner, a family, young children? Do you have pets? Are you buying a home in the near future?

"What your rainy day fund will look like if you're a homeowner is going to be bigger than if you're a renter. If you own a car, it's going to be bigger than if you take public transit. Pets are also a big thing that people don't think about," says Steacy.

Figure out what your rainy day might look like, and then tally up those costs to approximate a good target amount. While some suggest $1,000 as a starting point, the ideal figure should be one that you're comfortable with. Ask yourself: how would that amount feel on a rainy day? Is it sufficient so that the prospect of paying for your dog's emergency surgery wouldn't make you anxious? Is it adequate for a new desktop computer should your current one break down?

Once you've determined how much you need for your rainy day fund, go back to your budget. You can think about how much you can start setting aside for it. Then, divide your target amount by the monthly rainy day fund budget. That's the number of months it will take for you to come up with your fund.

Don't worry if it feels long or if you're starting small. The most important thing about a rainy day fund is that it exists.

Where Should You Store Your Rainy Day Fund?

Because of their purpose, rainy day funds are best stored somewhere accessible and in a form that's readily usable: cash. 

Steacy says she likes to keep things simple: get a high-interest savings account. The key is to keep it separate from your checking account. 

She also advises having separate rainy day funds for different purposes, if you can. "You want to have three rainy day funds - your car rainy day, your home rainy day, and one for something else." Then nickname the accounts, so that you know what they're for. 

Because the cash will remain untouched until a rainy day, it's best to put it in an account that will yield high interest over time. That being said, it's important to remember that rainy day funds are not investments. It's important to let go of the idea that we'd be missing out on potential 'bonus money' if we don't invest our rainy day funds or find ways to grow it, says Stacy. "This money really does need to sit idle - that's what it's meant to do."

Isn't this the same as having access to a line of credit? Not really. Resorting to a line of credit for rainy days, says Steacy, means you have access to a line of borrowable money, not access to actual money. "That shows that the behavioural side - of putting money away every month - is not there."

Once you have your rainy day account, it's time to start funding it.

How to Start Building Your Own Rainy Day Fund

Remember, it's important to be realistic about what you can set aside. Don't be discouraged if it seems like a small amount — the best place to start is where you are now. Here are the four top tips to get your rainy day fund started.

1. Consider Creative Lifestyle Changes

A great place to start when looking at your rainy day fund is spending. See where you can cut expenses and put that little bit into your account. 

Fewer takeaway dinners a week? Splitting your Spotify, Netflix, and Disney+ accounts with the family? Replacing your daily latte run with learning to prepare a good brew at home?

While we do miss happy hours with colleagues and catching up with friends at a favourite restaurant, dining out less during the pandemic may be giving you a headstart in putting away some money. Also consider relocating what might have been your leisure or travel budgets to your rainy day fund, for now.

2. Automate It

"Automate everything. Make it a payroll deduction," advises Steacy. "Set it up on a bi-weekly or semi-monthly basis."

Consider doing this once you set up your rainy day fund bank account. It is nice to see a large chunk of money in our accounts, but that chunk is an illusion if the money is intended for a rainy day. Set it and then forget it. Make it easier for yourself to grow that fund. 

3. Don't Underestimate the Power of a Piggy Bank

If you find yourself unloading spare change every once in a while, consider storing it in a dedicated container. Use whatever you have at home, or for the fun of it, place it in a good 'ol piggy bank. The change adds up over time, and you never know how much you can save in the long run!

4. Consistency is Key

A rainy day fund is most ineffective when it isn't there. Start bringing it to life where you are, and start small if you have to. Ten dollars here, $50 there, $32.25 if that's what you have the month after. Over time, those small steps will add up. It becomes the fund that covers emergencies, all while sparing you a minute of financial stress. Your future self will thank you for it.

Stay Dry, Even on Rainy Days

It comes down to keeping things simple, says Steacy. "Getting a higher rate on your rainy day fund is not going to be what makes or breaks your financial plan," she says. "Establishing a rainy day fund and funding it is what's important - setting up that habit. So that emotionally, you don't have that anxiety when something happens."

Ultimately, there's nothing like adequate financial preparation for both the long and short haul. With a rainy day fund, you set ourselves up for a life with less financial stress and anxiety. Come what may, money will less likely be an issue when you have those expenses covered in a rainy day fund.