Banking 101: Do You Need a Rainy Day Fund If You Already Have an Emergency Fund?

Chances are you’ve probably read personal finance advice that says you should keep three to six months-worth of expenses in an emergency fund. You may also have heard that you should have a rainy day fund to pay for unforeseen needs.

You might be wondering, what’s the real difference between the two? An emergency fund is your safety net for major expenses, stemming from things like job loss or expensive medical emergencies. Meanwhile, a rainy day fund helps you pay for lesser unexpected expenses, like a transmission replacement for your car or a leaking roof.

While they sound similar, you need to save up for both sorts of emergencies. When you have a well-stocked rainy day fund and an emergency fund, you’re ready for whatever expenses life can throw your way without needing to resort to high interest credit cards or personal loans.

Rainy day fund vs. emergency fund: What’s the difference?

An emergency fund is a savings fund meant to cover major unexpected expenses. It can be used to cover anything from emergency medical expenses to a layoff and should be kept fairly liquid so you can access funds without delay.

Because people often rely on emergency funds to replace their income in the event of job loss or inability to work, your emergency fund should equal at least three to six months of basic living expenses. If you're dealing with extenuating circumstances, such as unstable income or a costly medical condition, you may want to save up closer to nine months of living expenses.

A rainy day fund is also a highly liquid savings fund you can tap into when unforeseen costs come up. Unlike an emergency fund, which is meant for big, life-altering events, rainy day funds are for smaller, less grave events. Whether your refrigerator stops working or your pet needs surgery, a rainy day fund can help you cover the costs.

Why you need a rainy day fund and an emergency fund

Imagine you're at the dentist with your kid, and you're told your child needs braces. This will cost you $2,500, after insurance. If you’ve got a rainy day fund, paying won't be a problem, because you've saved up the money you need for unexpected expenses just like this. However, what if the day after you drain your rainy day fund, you lose your job.

Unfortunately, there's no rule that keeps more than one emergency from occurring at the same time, especially after you've had to deal with unexpected expenses. Saving up for both major emergencies and minor hiccups ensures that you always have enough money on hand. It also allows you to pay for fun but necessary expenses, like a school trip for your kid, without leaving yourself financially vulnerable.

Dividing up your savings according to purpose is a crucial part of developing a sound savings plan, according to the Consumer Finance Protection Bureau (CFPB). The CFPB recommends thinking about your savings as filling four different "buckets": an emergency fund, a rainy day fund, a fund for annual or quarterly expenses, like insurance, and a fund for savings goals, like a vacation or the down payment on a house.

As Bob Hampton, a financial advisor with Impart Financial in Fort Worth, Texas, explains, maintaining a separate rainy day fund and an emergency fund is helpful if you are concerned about maintaining the integrity of the emergency fund.

Keeping some cash in a rainy day fund you can access immediately while stashing your emergency fund in an account that's a little harder to get to will help you avoid draining your savings impulsively.

How much should you save in your rainy day fund?

A rainy day fund will be smaller than an emergency fund. The exact amount will vary depending on your lifestyle — for example, homeowners, people with kids or pets and business owners will probably need bigger rainy day funds.

Start a goal of $500 to $1,000 for your rainy day fund. You can stop there, or, if you think your circumstances necessitate a larger fund, aim for up to $2,500.

It might be helpful to make a list of potential future expenses for you and your family and use that list to determine an appropriate savings goal. Chad Rixse, director of financial planning at Forefront Wealth Partners, says $2,000 should cover most unexpected expenses, but advises consumers to consider costs that might pop up soon.

"If you have an old car, for example, or a kitchen appliance that's on its last legs, you should have enough to cover those types of expenses," said Rixse.

How to set up a rainy day fund

Whether you can afford to save $100 or $10 per month, both Rixse and Hampton agree that the most important step is to start saving immediately. They recommend automating your savings in some way so you can put money away without even thinking about it.

You can set up automatic deposits from your checking account to a savings account to occur on a regular basis — for example, the day after you get paid. Hampton recommends going a step further and having a portion of your paycheck directly deposited into your savings account, if possible. This method of paying yourself first is typically far more effective than waiting until you've paid all your monthly expenses and then stashing away whatever is left.

Make sure to budget for your newfound savings habit as well. If you don't have a budget yet, you can create one by listing out all of your fixed monthly expenses, such as bills, and then deciding how much you'll spend on flexible categories, such as food, entertainment and clothes, based on your income. Include your monthly savings goal as a line item in your budget.

Here are a few more tips for building your rainy day and emergency funds:

• When you get an income tax refund from the Internal Revenue Service (IRS) or a bonus from work, save it. The average 2018 tax refund was $2,833 — that’s enough to top up your rainy day fund in one go.
• Alternatively, lower your withholding tax and save the extra money from your paycheck each month in your rainy day fund. That way you start saving without having to wait for a refund check.
• When you pay off a car loan or a student loan, save the amount you had been paying for the loans in an emergency fund or a rainy day fund.

Where to keep your rainy day fund

Your funds should be easily accessible, which still leaves you with several options of where to keep your money. The easiest option is to keep a $500 to $2,500 cushion in your checking account by maintaining a balance above that number.

However, you probably won't be earning any interest if you go that route. Without interest, your money can lose some of its value over time due to inflation. If you want to earn a little interest on your money while keeping it liquid, you'll want a savings account.

Rixse recommends an online high-yield savings account. These savings accounts offer higher interest rates than those at traditional banks. Keep in mind that it can take a few days to transfer money from a high-yield savings account into your checking account if they're held at different banks. If you prefer to be able to withdraw cash from your savings account, look for high-yield accounts that offer an ATM card.

You could also consider a money market account or a no-penalty certificate of deposit if they offer a higher interest rate. Money market accounts allow you to write checks and withdraw money with an ATM card, whereas a no-penalty certificate of deposit allows you to withdraw your money at any time without incurring a penalty. Both offer higher rates than a typical checking account.

The bottom line

No matter how well you plan, life is full of the unexpected. Filling up both an emergency fund and a rainy day fund will help you make sure that a bump in the road never becomes an impassable mountain. Finding space in your budget for a savings account can be difficult, but once you get into the habit of stashing money away, you can experience the financial freedom to pursue your goals without sacrificing your peace of mind.