Rainy Day Fund vs. Emergency Fund: What’s the Difference?

One is for unexpected costs. The other for more dire circumstances

Dawson Tang
Contributing Writer at Tally

When talking about saving money, the first thing to discuss is having a rainy day fund. This is in case an unexpected expense, such as a medical cost or car repair, comes up out of nowhere.

If faced with an unexpected expense of $400, 41% of Americans said they would go into some form of debt to cover the cost, according to the Federal Reserve Bank.

That means that they’d likely pay for it on a credit card or borrow from friends or family. And putting it on a credit card means they might carry a balance, meaning they could incur interest. Some people also said they would simply be unable to afford the $400 expense and would leave it unpaid.

So, if you’re looking to stay out of debt, it’s important to have a well-funded rainy day fund.

What’s a rainy day fund?

Rainy day funds and emergency funds are often muddled together, and you may not have even realized that there is a difference!

A rainy day fund is exactly what we’ve already discussed: money saved up for an unexpected, one-time expense. It should be readily available so you can withdraw it at a moment’s notice without any fees or penalties.

In general, financial advisors recommend saving around $1,000 in your rainy day fund, but that really depends on what kinds of expenses might come up. While they’re of course unexpected, you may have some inkling as to what emergencies could arise:

  • Do you drive an older car to work every day?
  • Do you have pets that might need medical care?
  • Or maybe your refrigerator is on its way out?

Save enough in your rainy day fund so that, when life comes at you, you’re ready to cover that $400 (or more) expense without having to go into debt.

What’s an emergency fund?

An emergency fund is different. It’s intended to cover you in more dire circumstances, like a job loss or a major illness. Financial advisors often recommend saving between 3 and 6 months’ worth of your living expenses in an emergency fund. This is considered a safe amount that should give you enough time to get back on your feet.

On the other hand, financial economists Jorge Sabat and Emily Gallagher crunched the numbers and found $2,467 to be a good minimum starting point. In their new report, Sabat and Gallagher found lower income families who are able to save at least that amount drastically lower their likelihood of experiencing major financial troubles and falling into poverty in the future.

Remember: You can always save more than $2,467. Every dollar you save up to that number lowers the chances that you’ll experience major financial troubles in the future, but you might still need more! 

The ideal amount of money in your emergency fund depends on your specific situation and things like where you live, the stability of your job and if you’re single or have a family depending on you. If you’re single and your job skills are in high demand, maybe you only need to save 3 months’ worth of living expenses. But if you have a family and kids relying on your income, it might be worth saving up closer to 6 months of expenses.

Where should I put all this money?

Now to the mechanics of it all. If you’re trying to save for a rainy day or a longer-term emergency, you want to make sure you keep it in the right accounts so you have easy access to your money when you need it, while also maximizing the returns you earn.

For your rainy day fund, consider keeping your money in some kind of high-yield savings account at an online bank or your local credit union. Interest rates on high-yield savings accounts have been increasing ever so slowly in recent years.

In today’s market, you should be able to find a savings account that offers you about 2% annual percentage yield (APY). That will help combat inflation — which, thus far for 2019, has clocked in at 1.7% — so that you’re not losing money by keeping it in this savings account.

For your emergency fund, it’s important to find someplace that earns some interest — since this money could sit around unused for years — but still provides a safe return for your money without too much risk. In this case, you may decide that simply opening another savings account, separate from your rainy day fund, is good enough. You might also consider investing in the market in something like a money market fund, which may provide greater returns on your money.

However, putting your money in a savings account or money market account (not to be confused with a money market fund) is the safer option, since this money is insured by the FDIC up to $250,000. If you decide to invest your emergency fund into stocks or other financial products, there is a possibility that you could lose money. It’s ultimately up to you to assess your financial situation and decide what level of risk you’re comfortable with.

How do I get started?

When saving money for anything, the important thing is simply to start saving, even the smallest amount. Make a habit of it and work toward your goals over time. No one is necessarily expecting that you’ll suddenly have 6 months’ worth of living expenses saved up overnight. (Unless you already do, in which case, good on you!) 

The Consumer Financial Protection Bureau (CFPB) launched its Start Small, Save Up initiative in February 2019, and it has some useful reading and resources to help you get started with your savings:

  1. Start by coming up with your own savings rule, essentially deciding for yourself what you want your savings goal to be and what’s feasible for your situation. If you can spare $20 a week, you’ll end up with $1,000 in a year.
  2. Next, the CFPB came up with a worksheet to help create a savings plan, just to help you create a simple budget and think through how to stick to it.
  3. One tip is to take your tax refund (if you get one) and use it to jump-start your savings. Even if you only use part of your refund for your rainy day or emergency fund, that’s a great start.