What should be in my ‘rainy day’ fund?!
We recently wrote a post about budgeting (https://medium.com/@kakeibo/ive-made-a-budget-why-do-i-still-have-no-money-1c3a9c3f996e#.rr0gul1wg) and in that we explained how it is best to build a ‘rainy day’ saving fund into your budget. What we didn’t say was how you worked out what your ‘rainy day’ fund needed to be. This post should help to resolve that!
Before we start, it is important that we are all on the same page. You NEED a rainy day fund, whoever you are and whatever your circumstances. Unexpected things happen and they can cost a lot of money, so you need to be prepared.
Even if you are in a dire money situation and have problem debt, you should still put something away, particularly as you are already on the edge finance-wise, therefore a financial emergency could leave you with more serious problems.
As an example, if you use your car to get to work and it breaks down, how are you still going to earn money if the issue isn’t covered by insurance and there are no other travel options?
Ok, all on-board?!
Let’s talk about how to work out how much you need to aim for
As with all goals, you need to work towards them, don’t be daunted by the total. If you are starting from nothing, then it will take a bit of time and you will need to get into the habit of putting away some money ‘just in case’.
We use 4 categories of rainy day savings:
1. Car and house repairs — you need to protect the assets that allow you to live your life and stay safe and dry. Make sure you have funds to kick things ticking along and avoid expensive repairs in the future.
2. Insurance excesses — you will all have an excess on pretty much all of your insurance policies. If you don’t have the money to cover these, then you will be unable to claim when you need to.
3. Loss of earnings — I hope that you never have to experience redundancy or a situation where you are unable to earn, but these things do happen, so you need to be prepared.
4. General — this is where we suggest a little extra for completely unforeseen events — aim for something like £300 initially, but see what you’ve spent in your budget tracking over the last year that you didn’t expect, that is a good place to start. Hopefully as you refine your budget this will become smaller over time.
Work out your risks
This is something that all good businesses do, but it applies equally to your personal finances and gives you a structure to base your savings on.
You will need to assess the risks based on your circumstances. Everyone lives a different life and has different commitments, but based on these we are exposed to a variety of risks, which then help us to work out our rainy day fund. We find this easiest to map out on a simple graph of potential (%) and magnitude (£) like this:
Don’t worry about being too scientific on where the dots are, this is just an indication and will become more precise over time. The idea is to brainstorm as many potential eventualities as possible, but start from things that have caught you out in the past and work from there.
What have your friends and families experienced? Discuss it with them too and make this graph as comprehensive as you can.
You should revisit this every 3 months or so, noting down any new emergencies that cropped up, moving the position of existing points if circumstances change.
For example, we moved house last year into an older property, so the potential of house repairs has increased significantly, along with the magnitude!
Don’t forget that some of these risks are already insured. This is a great exercise in working out whether you have enough cover and even if you really know what you are covered for. There are many people that make assumptions and find out the hard way when they want to claim.
Make a note of which risks are covered by insurance, but also what the excess on that cover is — that then goes into the savings pot.
Calculate an estimate of the outlay for each of the risks and then bucket them into totals based on the categories above. The total of these four is what you should aim to put away. Break it down into a monthly achievable amount and get saving!
Initially, if you have nothing saved, you could choose to save for only those risks that have a high potential % and high magnitude, but over time you should work towards covering yourself as far as possible. After all, you will hopefully be earning interest on that money anyway.
Warning — ONLY dip into this pot for emergencies — you need to be firm with yourself, otherwise this will never work. Make sure the savings are transferred automatically at the start of the month and stashed away in a different account.
What now? Be strategic!
Once you are up and running with your rainy day fund and have met the initial goal you set for yourself, feeling all warm and fuzzy inside, then you need to get strategic with it!
We said you need to put away money to cover your insurance excess already, but what if you used this to your advantage? Insurance policies by their very nature are based on you only making infrequent claims, if ever. That money is then sunk.
One of the factors in working pricing your policy is the voluntary excess that you are willing to pay. When you come to renew your different policies, you could play around with your voluntary excess and see how much your policy comes down if you increase the excess you are willing to pay. Then save for this and do the same next year. It is possible to save quite a lot of money this way!
Hopefully this was useful in explaining one of the ways to come up with your rainy day fund total to aim for. As a summary the key steps are:
- Understand your circumstances and risks
- Work out the potential and magnitude of each
- Add up the total
- Get saving!