Why Save for a Rainy Day?

Marin Mommies presents a guest article by Marin mom and financial planner Tanya Steinhofer, CFA,CFP®. 

Whether or not the groundhog saw his shadow back on February 2, it makes good financial sense to plan for a rainy day. Life has a way of throwing curve balls into the best laid plans, be it job loss or unexpected expenses. One of the easiest and most emotionally satisfying ways to be ready for the next curve ball is to have a cash cushion to draw on if something unforeseen happens.

1. How much is enough? Standard advice is that you should have three to six months’ living expenses in an emergency savings account. Reality is a bit more nuanced. The ideal target is sometimes a matter of personal risk tolerance and your circumstances. I ask clients about their job security and job search history. I advise clients who have a family depending only on their income to err on the high side. Younger, two-income couples might be comfortable on the lower side. Some risk-adverse clients might need a years’ worth of living expenses in cash to feel comfortable.
2. Where do I stash it? It’s generally best to keep your emergency savings in the bank. If you want to put it in just one account, put it in a high-yield savings account linked to your checking account. Online banks like CapitalOne 360 offer higher interest rates than most traditional banks. Given how low interest rates are, you might wonder if you could earn a higher return on cash you are unlikely to touch any time soon. I sometimes advise my clients put a portion of their emergency savings in a very short-term bond fund to earn a bit more than savings. The understanding is that the value could go down, but probably not by much.
3. Can I use it to go on vacation? Emergency savings is for just that - emergencies. You should not use it to pay for expenses you can and should be budgeting for. For vacations, normal auto and home maintenance, you should be setting aside money each month for the projected annual expense. Emergency savings should be used if you lose your job or you incur an expense that is higher than you budgeted. If you do use some of your emergency savings, you should rebuild it back to its target.
4. Why not just use my credit card? While you can certainly use your credit card to pay for your unexpected expenses, you’ll build up revolving credit card debt if you don’t have emergency savings to pay the bill. A cycle of debt run-up, then debt pay down can ensue, with all the associated emotions with carrying this type of debt and interest expenses along the way. You’ll find you sleep better at night if you maintain a reasonable amount of emergency savings.

Tanya Steinhofer, CFA, CFP® is an independent, fee-only financial planner helping busy families achieve financial peace of mind by exploring and integrating their dreams into their financial roadmap. She offers comprehensive financial planning, but doesn’t manage assets so there are no account minimums to worry about. She lives in Mill Valley with her husband and two young children. She can be contacted at tanya@redwoodgrovewm.com or you can visit her website at www.redwoodgrovewm.com.