The Life-Changing Difference Between an Emergency and Rainy Day Fund

Emotion reeks far more havoc on people’s money than inflation ever will

In a recent Medium article, I suggested considering a rainy day fund in addition to your emergency fund.

My income allocation strategy includes holding a lot of cash. The self-proclaimed personal finance experts hate this.

They say I don’t understand how inflation and the purchasing power of money works. The cash you save today will not buy the same amount of goods in the future as it does today. Put another way, it will require, say, $1.20 in X number of years to obtain what costs $1.00 today.

This is actually incredibly easy to understand. And even easier to explain.

It’s not so easy to explain life.

It’s even more difficult to talk a friend down when they’re freaked out about having enough money to pay their bills. You can help your friend better situate their finances. However, if the first thing you explain to your friend is inflation, you’re a bleeping know-it-all who is ultimately doing them a disservice.

The best advice you can give anyone looking to situate their personal finance is to determine how much cash they need on hand to meet their obligations, cover periods of reduced income, achieve additional goals, and make them feel secure enough to keep the money they eventually invest in the stock market invested. It’s pointless to tell somebody to invest their money rather than save it if all they’re going to do is turn around and panic sell because they need — or feel as if they need — the cash.

Explaining inflation makes people feel smart. Trying to understand emotion makes them feel uncomfortable. Yet, emotion reeks far more havoc on people’s money than inflation ever will.

Emergency Funds and Rainy Day Funds Are Not the Same Thing

We don’t make this distinction enough.

Keep an emergency fund to cover nothing other than a loss of income — in part or whole. Use a rainy day fund to take care of the random things in life that come up.

It’s simple but crucial. It’s also easier said than done.

Why This Is Life-Changing

If you can master the following:

• Handling your monthly expenses with enough of a cushion to pay for the random things in life that come up out of your checking account.
• Stocking a 6-to-12-month emergency fund and NEVER touching it.
• Keeping a $1,000-$3,000 rainy day fund that you rarely, if ever, access.

You’ll be set for life. It will literally change your life. You’ll never have to worry about money again. At a minimum, you’ll worry a lot less about money than you did when you didn’t have a well-thought-out plan.

Most people bring a knife to the gunfight that is the war we wage with money on a daily basis. (Credit Taylor Swift for the rhetorical brilliance). We go through life without enough cash to make us feel comfortable. Cash secure.

Then somebody comes along and tells you you should be investing your money because of inflation. On the surface, this is excellent advice. However, if you invest too much — even any amount at all — too fast, you’re setting yourself up to fail.

Even though money in an investment account is really only a couple to a few days away from your bank account, it can feel like it exists in a far off land. At least this is how it has always felt to me. This dynamic caused me to panic sell stock and face the following consequences:

• You sell for a loss. Days or weeks later, the stock you sold goes on a run. You rush to buy it back. It drops. You sell for a loss — again — to, oddly, cut your losses.
• You sell for a gain. The proceeds hit your bank account. You spend them. At tax time, you pay capital gains taxes. For all intents and purposes, this is a net loss.
• You stunt the wealth-building process. If you buy dividend-paying stocks, you can reinvest the dividends you receive into new shares of stock. Over time, you benefit from the power of compounding. Selling halts this process. You can’t pick up where you left off. It doesn’t work this way.
• You feel like a failure and give up on investing. Putting money into stocks becomes a toxic and stupid process. You begin to wonder what it’s worth if you’re constantly taking one step forward and two or more back.

These cycles create bad savers and investors.

Money Can’t Buy Happiness, But It Can Quell Anxiety

The less anxious I am, the happier I am. I’m less anxious when I feel cash secure at the same time as regularly buying stocks.

So, maybe, in a not so roundabout way, money can buy happiness. It’s at least an important intermediary.

We spend our lives chasing money. For all the wrong reasons. We spend too much. We never have enough. We keep chasing.

When you finally figure out and commit to the notion of an insanely low cost of living and strategic budgeting, spending, saving, and investing, it ceases to become a chase. Money becomes a tool on the road to financial flexibility.

But it goes beyond even that.

For some people, money is always their number one stressor. It’s also one of the few stressors we often require more of to relieve the stress. It tends to not work this way with, say, cocaine, or something. More cocaine can work for a while, but you’re probably never going to win heading down that path.

If you use money wisely as you take more in, you can alleviate stress. It’s all about adjusting your relationship with money. Getting money and spending it on things we don’t need only leads to additional stress because it makes it more difficult to solve the core problem of making ends meet. Getting money and crushing the personal finance game with it takes care of what ails you—not comfortably getting by.

It all sounds so simple. But it’s not. Easier said than done.

This said, if you consider emotion before inflation, I’d be willing to bet (though that’s a poor use of money), you’ll set a trajectory for financial success. Putting the nuts and bolts components — ample cash to cover life, and then some — in place will literally change your life.

It’s that simple. Even if it’s not.

This article is for informational purposes only, and it should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions