Building Your Rainy Day Fund

By John Focht

Setting aside money each paycheck is tough on many fronts.  First, how and where do you actually find the extra dollars to squeeze out of your pay to set aside?  And second, isn’t it nicer to reward yourself with something you actually want with those extra dollars you squeezed from your pay?

Sure it would be nice to use the extra savings from your pay to treat yourself to something nice, or spend an extra round on the golf course, but it’s also important to set aside for that rainy day just in case.

Most financial experts agree after you put savings away for your 401(k) and IRA , the next important savings spot for you is building a six month cushion in cash.  Building a rainy day fund of about six months of salary provides you some emergency cash if you are ever in a situation where you are laid off or lose your job.

Building a rainy day fund also affords you the opportunity to have immediate cash on hand if you need it for a household emergency like a new roof, hot water heater, refrigerator, or washer or dryer.

Also, be sure to save in a money market or cash savings account.  You should not be saving a rainy day fund in any type of stock or high-risk mutual fund.  If the stock or mutual fund takes a hit, your cash reserve fund will also take a hit.

So, how much should you save each paycheck?  Start with whatever you can actually set aside.  A good starting point is taking stock in how you are currently spending your money. Once you have a good sense on what your spending habits are, it will be easier to start saving a little extra each paycheck.  Creating a family budget will go a long way in helping you toward building a cash reserve fund.

Once your spending and budget are in check, setting savings aside each paycheck should come with ease.  Put aside whatever you can initially with the goal of eventually setting aside 10% of your paycheck toward savings.

Continue saving until you hit that six-month salary mark.  Once you do, reward yourself with something nice.  Next, it’s to start setting aside savings for the kids college!


Setting Aside for Your 401(k)

Most financial experts will tell you the importance of saving for retirement, for college, and saving for a rainy day.  All sounds good in theory, but how do you get there?  After all, there’s the mortgage, bills, kids’ activities, and the list goes on and on.  How do you get to the point where you can save for retirement, the kids’ college, and for a rainy day?

First you need to get to a starting point and begin laying out a plan.  Your plan should not focus on saving for all major savings goals all in one shot, but instead should focus how you will cut back your spending over the next few months in order to start getting to your savings goals.  If you try to figure out immediately how to save for everything, you will be overwhelmed with the whole idea of saving.

Most financial experts agree that the first major savings goal you should look to accomplish is maxing out your 401(k) contribution to meet your employers matching program.  By putting a percentage of your paycheck into your 401(k), you have accomplished two tasks: lowered your taxable income and increased your pay from your employer.

By investing in your 401(k), you have lowered your taxable income by the percentage of savings you are deducting from your paycheck into your 401(k) account.  All monies invested into a 401(k) are pre-taxed, so that 2% or 5% or 10% that you put into your 401(k) has decreased your taxable income by that amount.

Secondly, employers match up to a certain amount of your 401(k).  Whether they match dollar-for-dollar, or 50% of the dollar up to a certain deduction amount, it is still additional pay your employer is giving you.  Granted you will not get that money until at least 65 years of age, but it still increasing your pay and the money your employer is paying you.

At bare minimum, you should be investing into your 401(k) as much as your employer matches.  If your employer matches dollar-for-dollar up to 4% of your investment, you need to figure out a way to invest 4% of your paycheck into your 401(k).  If your employer s matching 50% of your investment up a certain percentage, say 6%, you again need to find a way to invest 6% of your pay.  After all this is basically free money your employer is giving you to invest in your 401(k).  You should figure out immediately what expense you need to cut back on to get that 401(k) match from your employer.

Once you have put yourself in position to save for your 401(k), you can begin looking at the next hurdle you need to save for.


Where Does Your Paycheck Go?

Creating a family budget is an important step in securing your financial freedom.  A budget won’t free you from your responsibility in paying your bills on time, but it will steer you in the right direction of knowing where your money is spent each month.  It will also get you on the path to effectively start saving money on a month-to-month basis too.

Before trying to establish your budget, you need to start with the basics and understand what you are currently spending your money on.  How much do you spend on groceries each month; gas for the cars; heating, electric and water; cable and internet?  How much are you spending each month for going out to dinner or going out to lunch; extra-curricular activities for the kids?

After you have determined what you spend your paycheck on, it’s time to sit down and begin calculating out how you will begin to budget your paycheck.  First, list out on a spreadsheet how much you are spending on each of your monthly bills. For example:

  • Electric:  $100
  • Internet/Cable/Phone:  $200
  • Groceries:  $250
  • Gas:  $120
  • Water Bill:  $35
  • Mortgage or Rent:  $1500

Once you have listed out your bills, calculate what you are spending per month on other expenses, like entertainment and activity expenses.  List them out on a spreadsheet as well:

  • Sons baseball camp:  $250
  • Daughter’s gymnastics:  $100
  • Family dinner nights out:  $250
  • Weekly lunches out:  $50

You’re not quite out of the woods yet with your bills.  Don’t forget some of your bills come on a quarterly, semi-annual, or annual basis.  It’s best to begin saving for those bills now, so when they do come due, you will already have money set aside for those bills and you won’t be forced to be looking between the sofa cushions to find lose change to pay for them.

  • Tax Bills
  • Life Insurance
  • Homeowners Insurance
  • Car Insurance

Once you finally have a full listing of your month-to-month bills, your month-to-month entertainment/activities expenses, and non-month-to-month bills, you are now in a position to sit down and create a family budget.

For the purposes of this article, we will pretend we get paid twice per month.  For your quarterly, semi-annual, and annual bills, figure out how much you need to save each paycheck in order to have enough money saved when the bills comes due.  For example, if your life insurance policy has an annual renewal amount of $300, that means you need to save $25 per month in order to have the $300 available each year ($300/12 months).  If you get paid twice per month, you need to save $12.50 per paycheck in order to have the $300 available at the end of the year.

Breaking it down to the smallest denominator also provides a more manageable way of understanding what you need to save for your bills.  Saving and setting aside $12.50 every two weeks is much more attainable and less overwhelming than trying to figure out how you will come up with $300 when the annual life insurance bill comes in.  This also gets you in the mindset that you need to save and set money aside to pay for to pay for those bills.

It’s also important to understand that the money you are setting aside for these non-monthly bills is not your savings, retirement, or “rainy day” money.  This money is specifically money you have ear-marked for these bills.  We will get into savings, retirement, college savings, and “rainy day” money in a later article.

Now do the same with your monthly bills and entertainment expenses.  Figure out what you need to save each paycheck in order to pay the bill at the end of the month.  For your $100 per month electric bill, you need to save $50 per paycheck; for the $1500 per month mortgage, you need to save $750, and so on.

At this point, you should have all your monthly bills and expenses listed out on a spreadsheet with the dollar amount it costs for each of those bills on a paycheck-to-paycheck basis.  Don’t worry that some of the bills aren’t at a fixed cost, like the grocery bill.  Your monthly groceries will fluctuate month-to-month, but you should have a solid understanding that you spend roughly $250 per month on groceries, which means you need $125 per paycheck to pay those groceries each month.

Once you have all your monthly bills, monthly entertainment/activity expenses, and non-monthly bills listed out and broken down to what you need to save per paycheck, compare this cost against the gross amount of your paycheck.  Is this amount greater than, less than, or equal to your gross pay?

If your bills and expenses are greater than your gross pay, you are in some trouble.  This means you are spending more than you make.

If it is equal to your gross pay, that’s not bad, but it’s not great either.  This means you are spending exactly what you are making.  You have no wiggle room if an unexpected expense hits you like a new roof, new water heater, or a new dishwasher.  You also have no room for any type of savings.  You are literally living paycheck-to paycheck.

If your bills and expenses are less than your gross pay, congratulations, you are in the black.  Next steps for you is to figure out the percentage of savings you can put aside each month.

Going through tasks above I a long and tedious process.  It can also be very frustrating figuring out exactly what you are spending.  The intention is not to micro-manage down to the penny what you spending, but instead begin to get you in the mindset of understanding what you are spending.

Once you have this basic understanding, you will begin to get a much better sense of what you can cut back on and how to begin saving your money for retirement, a general savings account, college accounts, and more.