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How to Build and Manage Your “Rainy Day” Fund

According to a study released by the Federal Reserve last year, Americans rank a rainy day fund as their top priority for saving money. The study found that the average size of Americans’ ideal rainy day fund is between 9% and 14% of their income – which translates to a little more than one month of paychecks.

The findings are surprising because for years studies by mutual fund and insurance companies have ranked retirement funding as Americans’ number-one concern, not savings. But what many might find most surprising is how much Americans feel they need to put aside for an emergency. The common wisdom among planners is that to be well protected against the loss of a job or large, uncovered medical expenses, six to 12 months of income is needed.

Considering that some 12 million Americans are still unemployed and that the average length of unemployment is more than nine months, it appears that the common wisdom is worth heeding. The truth is, however, that how big your own emergency fund needs to be depends on your own unique circumstances.

So what is the right amount and where should you keep it? Here are some considerations:

How secure is your income?

The rule of thumb here is: the less secure your job is, the bigger your rainy day fund needs to be. A household with two incomes is more secure than a household with just one. Someone who holds a union-protected job has an income that is more secure than a commissioned salesperson, and a college-educated, white-collar employee is generally more secure than someone who hasn’t finished high school.

How flexible is your lifestyle?

If you spend a lot on luxuries and entertainment, you may find it easier to absorb a sudden loss in your income than someone who lives modestly.
Are your expenses stable and predictable?

If your home and car are in good shape, you’ve had all the children you plan to , and everyone in your household is in good health, you may not need a large emergency fund.

How much of your find is in volatile investments?

If the bulk of your rainy day money is in the stock market, you should protect yourself against downswings, because your job is liable to be less secure exactly when they occur. You can find some of that protection in the stock market by diversifying, but you’ll also need to have more set aside.
How much are you counting on retirement savings?

Retirement accounts are the last place you should turn to for emergency funds. The main reason is that you’re still going to need those funds some day, and by spending them early, you’re eating into your retirement fund. Nevertheless, federal law allows you to make preretirement hardship withdrawals without penalty for certain specific reasons. But note: while withdrawals aren’t subject to the usual 10% preretirement penalty, they are subject to income tax, so your funds won’t go as far as you might think.

Having a rainy day fund should be one of your first financial priorities. The surest way to find the money to create it is to pay yourself first with every paycheck: authorize your bank to transfer a set amount from your checking account to a savings account, or go to the bank to make a deposit as soon as you’ve been paid. Think safety above all else when choosing how to invest your emergency fund.

For help deciding how much you need in your rainy day fund and the best places to keep your money, please call.

Copyright © Integrated Concepts 2012. Some articles in this newsletter were prepared by Integrated Concepts, a separate, nonaffiliated business entity. This newsletter intends to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects. The appropriate professional advisers should be consulted before implementing any options presented. No party assumes liability for any loss or damage resulting from errors or omissions or reliance on or use of this material.

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