Rainy Day Funds: What Are They and Do You Need Them?


One of the big reasons people don’t budget is because they get hammered by unexpected expenses. Perhaps you’ve experienced the same thing. Your budget has been going well for, oh, about 19 minutes, then “WHAM!” You need to pay the car insurance premium. Oh, and property taxes are due. Did I mention your daughter’s annual dance recital fee needs to be paid by Thursday? The oil needs to be changed. It’s also time for a transmission flush.

Welcome to life. It just came and hit you upside your head. And it will continue to do so as long as your ticker is ticking. Get used to it and do something about it!

Enter the rainy day fund.

What is a Rainy Day Fund?

The rainy day fund is a relatively simple concept. Let’s take the car insurance premium that you pay every six months. It costs $400. You don’t have to pay it every month, so most people would simply not worry about it. Whew! Wrong. It’s a predictable expense that will happen. You need to face reality. So $400 every six months is $66.67 per month.

Your rainy day fund will grow for six months by $66.67 per month, until you have $400. In that month, lo and behold, your insurance premium is due! You cut the check for $400 and you haven’t felt a thing. Welcome to rainy days – where you have an umbrella.

The rainy day fund is one of the most critical aspects of your personal finance strategy. The personal budget that I built for my wife and myself (and now sell – obviously) has this rainy day fund capability built in. It’s quite nice – I almost get emotional seeing it in action…

How We Use Rainy Day Funds

The way we do it personally? If we know there’s an expense, even a small one, like a magazine subscription for $20 ever year, we keep tabs on it. How much goes into the magazine category of the budget each month? $1.67. We have these reoccurring, predictable expenses in our budget, and we budget accordingly. As a result, we can pay our insurance premium in one lump, instead of monthly. This saves us $15. I don’t mean to beat a dead horse, but let me show you what kind of return this rainy day fund can potentially give you:

$415 premium paid every six months, discounted to $400 because of rainy day fund…
gives me an annualized return of 7.5 percent.

And here people worry so much about what rate this is getting and what rate that is getting. I just got 7.5% on my money. That’s not bad – aside from the fact that the rainy day fund gives you a return on (of) your sanity.

Planning for Unpredictable Timed Expenses

Now, what about something like auto repairs? You aren’t exactly sure when those are going to come about. Should you set up a rainy day fund for those also? You might consider it. I know that we spend X dollars, on average, each month. How do I know this? Because we track our expenses, which gives us a monthly average. So if I notice that our “Car repair” category is running a bit low – even though I don’t anticipate having any car trouble – it’s wise to throw some money into that category during the budgeting process. That way, if something does happen (and statistics are telling me it will), I won’t be left out in the rain.

Adding Rainy Day Funds toYour Budget

The YNAB personal budget system works in such a way that all of your spending categories can function as rainy day funds. You simply put in your monthly allocation and let the balances grow as needed. When you spend some money from that category, it obviously declines. My wife and I have had a lot of success with this one powerful aspect of the YNAB system. I also explain it here.

Take a moment to write down – simply brainstorming – all of your expenses. Work through it methodically. Write a little ‘RF’ next to the expenses where a rainy day fund would be helpful. You might find it helps with property taxes, Christmas, birthdays (gifts in general), car insurance, health insurance, vacation, magazine and newspaper subscriptions, etc. And that was just a little one-minute brainstorm. Keep a look out for any services you use that might give you a discount if you pre-pay your bill. Most companies appreciate the increased cash flow that gives them. So, you’ll “pay yourself” during five months, then during the sixth month, you’ll actually pay the provider. And there you have it, a great return on your money, and a return on (of) your sanity. The rainy day fund will keep you out of debt and on your way to financial peace and security.

Here at YNAB, we use rainy day funds as Rule #2 (embrace your true expenses) in our four simple steps to less money stress. Learn the other three rules and give budgeting with YNAB a shot!