How to save for a rainy day
Ask yourself four questions to help prepare for the unexpected.
Key takeaways
- Save at least 3 to 6 months' worth of necessary expenses by funding your emergency savings account regularly, as you would pay a bill.
- Consider saving in an account that pays some interest but allows quick access to the money.
- To really be prepared for anything, be sure to keep disability and critical illness coverage, and healthcare insurance to provide basic coverage or supplement government provision.
The forecast says rain? You pack an umbrella, just in case. Car has a flat tyre? Good thing you keep that spare in your boot/trunk. But what happens if your heater or air conditioning breaks or you unexpectedly lose your job? Do you have a "just-in-case" fund set aside? Maybe not. In many countries, people do not have enough saved. Here are four key questions to ask yourself to help make sure you can handle what life throws at you.
1. How much do you need?
Here's the short answer: We suggest setting aside at least 3 to 6 months' worth of living expenses. If you're single and on your own but have family support, you might be comfortable with 3 months of savings. However, if you have a partner, dependents, and a mortgage to support, you might find 6 months or even more would be more appropriate.
To determine what is right for you, there are some things to consider that could help you customize the amount you may need to save for your situation.
Protecting yourself or your family from a potential job loss or loss of income is generally the number one reason to save for a rainy day.
But your situation may not warrant saving as much as 6 months of essential expenses. If you could easily replace your job, saving 3 months' worth may be fine. If the opposite is true and it could be a long search to find a new job, saving up to 6 months' worth or beyond could make sense.
What about borrowing?
In some cases, borrowing to pay for an emergency might not be the worst thing. For instance, a home equity loan or line of credit, if available, could be an option.
You should consider two important items:
- If you've lost income, borrowing to cover essential expenses is risky as you may not have the income to repay them.
- If you already have a lot of debt, relying on credit or loans in an emergency puts you further in the hole, which just makes it that much harder to get out.
2. How to come up with the cash?
There are a couple of ways to boost savings—even on a tight budget.
Think of your emergency savings fund as a bill. With rent or mortgage payments, contributing to a retirement fund, and the range of living expenses, you already have a lot to balance. But if you turn saving for an emergency fund into a monthly priority, you’ll get in the habit of contributing to it regularly.
Save any inheritance or gifts. If you are left money by a relative, don’t use it all for daily expenses. Consider using it to start your emergency fund and invest what is left over for other savings goals.
3. Where to put your savings?
It can make sense to separate your emergency fund from your spending money and other types of savings. That could mean a savings account, which can be a convenient and accessible option. Do remember that interest earnings on those accounts may be considerably less than the rate of inflation.
As an alternative, fixed term savings accounts generally offer better rates than a typical savings account. In return for the higher returns, you commit to a fixed savings period. You may therefore be penalised for taking money out before the account matures. This may be a solution for a portion of your emergency fund but beware of tying up all your savings—a vital component of your emergency fund is the need for immediate access.
When you need to dip into your emergency fund, consider withdrawing from immediate access accounts first. An example of an immediate access account would be a savings account—your savings are easily accessed without penalty. Avoiding losses due to taxes, penalties, or market volatility is key.
Even if permissible, try to avoid withdrawing from retirement accounts if you're not yet of retirement age. You may have to pay taxes and penalties for the early withdrawal, as well as reducing the amount of money for use in your retirement years.
4. How to protect yourself with insurance?
Besides having cash that you can access in an emergency, insurance is another way to be prepared. Consider taking out insurance:
Check your life insurance. This provides protection for your family and dependents in the unfortunate event that anything happens to you, check the need to supplement any payments provided through work plans.
Look into disability insurance. Whether you have it through work or on your own, you'll want to know that you have enough in the event something happens.
Don't forget about health insurance. If you lose your job, your company-sponsored health coverage may go with it. Factor in some additional money to cover the cost of health care costs not covered by government programs, or to purchase your own health insurance, just in case.
The bottom line
There are many other circumstances besides losing a job that could require having cash on hand—like natural disasters, unexpected childcare expenses, or a surprise medical bill that the government or insurance won't cover.
You may not be able to plan for all of them but protecting yourself with insurance, having some cash savings that are easily accessed, and keeping credit available, just in case, make a good start.
That’s one reason that we suggest establishing an emergency fund and then continuing to save 5% of your after-tax income for unexpected expenses.
Everyone needs an emergency fund—no matter how old you are or what your income level is. And if you’re diligent about saving for it, you'll be better prepared for anything—rain or shine.
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