Why the Rainy-Day Fund is the Cornerstone of Successful Personal Finance
A few weeks ago, my infant daughter was admitted to the hospital after contracting a stomach virus. Due to some complications and a slow healing gut, what should have been a 3-4 day stay, turned into two weeks of my wife and I living and working out of the hospital while our baby girl recovered. I came away from the experience incredibly grateful for my daughter’s recovery and health, but also with a new-found respect for what I now think of as the cornerstone of successful personal finance: The Rainy-Day Fund.
Health scares are equal parts stressful, terrifying, humbling, and exhausting. It’s helpful to remember this because in the moment, you are not concerned in the least about personal finances. All that matters, is that you or your loved one is getting the care that they need and deserve.
That said, in the moments between the conversations with doctors or the acuteness of the scare itself, there is an itching feeling that slowly crawls up your spine, until it manifests into a single anxiety-inducing thought:
How are we going to pay for this?
The Grim Reality of Emergency Expenses
Most Americans do not have funds available for emergencies. The US Federal Reserve recently noted that the 44% of Americans could not afford an emergency $400 expense, and would simply be unable to pay or would have to borrow or sell something to pay it (Federal Reserve).
To put this in context, the deductible on a high deductible health insurance plan (which comes with lower monthly premiums) is at least $1,350 for an individual or $2,700 for a family. However, many high deductible plans, such as my own, have higher deductibles. For most families, $2,700 or more is a lot of cash, especially when you consider that 44% of us would not be able to afford $400.
More, the out-of-pocket max on your health insurance might be significantly higher than your deductible due to co-pays. For example, though the deductible on a standard low deductible/high premium plan might be significantly lower than a high deductible plan, it is possible that the out-of-pocket max is higher. This fact could make long hospital stays or dramatic health events particularly difficult from a financial standpoint.
It can go beyond health as well. Meeting a $2,700 health insurance deductible (or higher) may pale in comparison to the ‘cost’ of losing one’s job. Damage to your home or other property that isn’t covered by an insurance policy can be expensive. Buying plane tickets to travel to a loved one in need can be financially burdensome. These are all reasons to build up your rainy-day fund.
Planning for the Unexpected
My family happened to be in a unique situation, as we had already planned on at least getting close to the family deductible on our high deductible health insurance plan early in the year due to the birth itself. That said, after our two week ‘staycation’ at the children’s hospital, we were now assured of it.
If you have a high deductible health insurance plan, you should have the cash set aside (ideally in your Health Savings Account or ‘HSA’) to pay your deductible every year.
But, you may say, I have never once hit my deductible. I rarely go to the doctor at all. Why should I save up for it?
Rainy Day Funds are not about what you plan for. They are for the events in life that you never could have fully expected.
Disease, illness, injury, damage to personal property – these are by their very nature unexpected events. So, we plan for the unplannable. We prepare for the unexpected so that if it occurs, money can stay off your mind and you can focus solely on the things that matter.
During my client consults, there is always a point where we discuss how much cash they should have on hand for emergencies. Some have amassed way too much of it and we must find a happy medium for them. Sometimes this is three months of expenses. Sometimes, it is six months or even twelve before they feel secure. Other clients tell me that seeing that much cash in their bank account makes them feel ‘flush’ and itching to go on a vacation or a shopping spree.
At the end of the day, every individual feels differently about having some cash socked away for a rainy day. The art is balancing the inclination to spend or to hoard with real-world potential need.
However, no matter where you fall on the spectrum, the point is the same, the rainy-day fund is at the core of any successful financial plan.
- If you have a rainy-day fund in place you have shown an ability to save and are less likely to rely on credit cards to juice your spending power.
- Without an adequate rainy-day fund, any of the events described above could put a family in serious financial hardship.
- Having a rainy-day fund in place allows you to invest more aggressively (whether by amount or risk capacity) in other areas, such as your retirement accounts, business investments, entrepreneurial ambitions, or even career growth.
- Having a rainy-day fund in place lowers the risk of needing to prematurely tap into your retirement accounts, avoiding the 10% early withdrawal penalty and allowing your retirement funds to continue growing.
- Adequate emergency savings increase life optionality. Though we often think of money in terms of the ability/inability to consume, true financial well-being is about increasing your ability to choose how to spend your time. Being debt-constrained with little cash and/or retirement savings is limiting and does not leave you with many options. On the other hand, having an adequate rainy-day fund is the first step to increasing your own financial freedom.
- For example, though not necessarily an ‘emergency’, having adequate cash savings could allow you to front the moving costs to take advantage of new job or opportunity in a different city.
What should a rainy day fund look like? How much money should you have in it?
Though each situation is unique, there are some general rules of thumb that can help you as you build your emergency fund. Here's the list:
Rainy-Day Fund Basics
- Your Rainy-Day Fund should be held in a readily available checking or savings account.
- For most individuals, a rainy-day fund of 3-6 months of monthly expenses is usually satisfactory.
- For business-owners, salespeople, employees who work on commission, or anyone else with variable income the rainy-day fund should be increased to 6-12 months of monthly expenses.
- Individuals with an unstable employment situation should consider increasing their rainy-day fund to the 6-12-month range, as well.
- Whatever this amount is, it should adequately cover your out-of-pocket max on your health insurance, your car insurance deductible, home insurance, and any other deductibles on personal property.
- If you are tempted to dig into your rainy-day fund for a luxurious vacation or an online shopping binge, put it into a different bank account that is less accessible than your normal day-to-day checking account.
Real Financial Planning
As an aside, I came away from my experience at the hospital with a newfound respect for real financial planning. When most people think of a financial adviser, they unfortunately think of someone who just wants to sell them an insurance policy or a ‘perfect’ investment. But a real financial planner takes an-depth look at every facet of an individual’s or family’s financial situation. Stock market risk is important and should be considered by financial professionals. However, real life risk can be dramatic in scale both personally and financially. If we as financial planners do not speak to this we are not doing our job. I am grateful to be a part of a new generation of real financial planners who take a holistic approach to the family balance sheet.
Sick of working with an ‘adviser’ who just tries to sell you insurance and other commissioned products? Ready for the more holistic and comprehensive experience of real fee-only financial planning?