Rainy Day Fund: A Financial Firewall
When you’re flirting with financial insecurity – living from paycheck to paycheck – the first order of business you should tackle is to accumulate 3 to 6 months of liquidity to meet unexpected expenses.
Where to start? You’re just out of school. You have a new job. You finally have a steady source of income. And you feel like it’s time to put some financial order in your life. You’ve probably read or heard comments in the news media that most individuals/families would be hard pressed to meet an unanticipated $500 expense. I found that hard to believe until a couple of years ago when a major local disaster – the August 2017 Hurricane Harvey flood – damaged over 200,000 homes in the Greater Houston area. This devastating event left thousands of gainfully employed people in a major financial pickle. It compelled me to write an article that my daughter published in her informative website (http://youmeandthetree.com/). She posted it under TIPS FROM POPS and titled it “Harvey, Irma and the Importance of Rainy Day Funds”.
A rainy day fund, huh? When you’re flirting with financial insecurity – living from paycheck to paycheck – the first order of business you should tackle is to accumulate 3 to 6 months of liquidity to meet unexpected expenses. Think about it. Most young people on the front-end of their first good job with generous benefits often can’t even meet medical plan or auto insurance deductibles much less the cost of unexpected emergencies. So, they should start building a liquid rainy day fund… money that’s deposited in an easily retrievable but separate bank account.
In the case of the Harvey flood, I wasn’t referring to the Texas Legislature’s multi-billion-dollar “Economic Stabilization Fund”, a type of governmental rainy day fund used for disaster relief. I was speaking of the tens of thousands of individual Texas Gulf Coast citizens who, tragically, found themselves with flooded homes, soaked furniture, ruined automobiles, moldy clothing, and in some cases, an interrupted paycheck. Seventy-five percent of these folks were located outside the 100-year flood plain, not covered by flood insurance, and without a personal rainy day or emergency fund to help restore their lives to normal.
According to a FINRA Investor Education Foundation Study, 56% of people nationally don’t have an emergency fund large enough to cover 3 months, much less 6 months of unexpected expenses – outlays such as major auto or home repairs, job loss, medical emergencies, unplanned travel expenses and… ahem… flooded homes. Sixty-four percent of Americans don't have enough cash on hand to handle a $1,000 emergency expense, let alone an uninsured flooded home, according to a survey by the National Foundation for Credit Counseling. Twenty-five percent of Americans don’t have a rainy day fund at all. Many of these folks do, in fact, live from paycheck to paycheck, often by necessity, choosing to run the risk that no major financial disaster will uproot their lives. It’s a good bet that one week before Harvey struck, most Houston and Harris County, Texas, citizens barely gave a tropical depression in the Southern Gulf a second thought… or if they did, bet that it would not veer north with uncommon fury.
So, what happens when individuals or families without rainy day funds suffer a financial setback. They borrow from family or friends. They neglect to pay other bills. They sell or pawn other assets. They get a cash advance from a credit card company. They mostly do those things that simply exacerbate their financial woes. This is why I titled this blog, A Financial Firewall. In addition to helping meet those unexpected expenses, a rainy day fund helps avoid disruptions in meeting the goals of a long-term financial plan. More on that in later blogs.
So, how does one begin the process of building an emergency fund? First, don’t set initial emergency fund goals so high that you soon deem them unrealistic or unattainable. One hundred or one thousand dollars is better than nothing, and when you hit that mark, strive for two hundred or two thousand dollars… then three hundred or three thousand, etc. To protect yourself against the possibility of a major emergency, develop a working relationship with your local banker and establish a meaningful line of credit. Money that could be borrowed in case of a financial emergency. And in that instance, use your smaller rainy day fund to supplement the line of credit.
Where do these emergency funds come from? As sources of funds, reduce or eliminate spending on nonessential goods and services while building your nest egg. Use spare change – dimes, quarters and dollars – or an unexpected salary increase, a tax refund, or a few restaurant meals foregone. You might even have that bank mentioned above automatically shift a small amount of money ($25-$100) from your checking to your emergency account each month. After a month or two of shifting, you might not even notice the difference, and it adds up quickly!
But in getting started, ensure that basic day-to-day needs are met to avoid discouragement during the accumulation process. And be wise, keep your emergency funds in a separate account; one less accessible than your regular checking or savings accounts. And DO NOT carry a debit card tied to that account. Make it a bit inconvenient to access these funds. In short, make the account accessible, but not too accessible. Force yourself to consider your actions before making a withdrawal. Accept the fact that all of us lack a bit of monetary self-discipline from time to time.
In short, a rainy day or emergency fund is a relatively accessible stash of cash for use only in case of emergency. Don’t use it to buy an automobile or computer. Don’t buy a new piece of furniture or remodel your kitchen with it, unless, of course, you had a rainy day fund and lived in the City of Houston and Harris County, Texas, back in 2017. By the way, Houston, a bustling metropolitan area well-stocked with numerous Fortune 500 companies, is also a population of folks with big hearts in times of great stress. In addition to friends and neighbors, hundreds upon hundreds of companies, large and small, came to the aid of Harvey victims – supplying employees with temporary housing, food supplies, interest free loans, grants and volunteer cleanup crews in addition to counseling and employee time off to take care of family needs. These were voluntary acts, and not all companies participated, but let us NOT forget about those many rainy day employers, friends and neighbors who did!
To drive this “rainy day fund” point home, in December 2018 The Federal Government halted the function of many of its agencies due to a budget impasse. Some 800,000 federal workers and service providers with very secure jobs missed a paycheck or two. As is typical of government shut-downs, those workers later received the missed paychecks, accrued sick and vacation time – and their pensions were calculated as if they had been on the job during the shutdown. Still, according to news reports, many of those government workers quickly began to experience all kinds of financial chaos. In short, despite holding very secure positions with the federal government, many of them could not handle this short-term financial disruption in their lives.
Simply put, a rainy day fund is your first step toward long-term financial security. And it also serves as a firewall protecting your long-term plan from short-term financial chaos.