Unforeseen costs can pop up without warning: The washing machine breaks down, tyres need replacing, pets need veterinary care...the list goes on.
Having to resort to a finance company to plug the payday gap is likely to cost more and cause unnecessary stress - and that's where a rainy day fund comes in.
- Move savings out of reach by opening a separate bank account - money expert
- Options for investing a bucket of cash
- Seven simple money hacks to help you finally stick to a budget
Dr Pushpa Wood, director of financial education at Massey University said that a rainy day fund is akin to being prepared for a change in the weather.
"If you expect rain, you would take a raincoat or umbrella - or better still, have those items at-the-ready in a handbag or car.
"[Similarly], you can plan and save for unexpected costs, so there's a resource in-place to protect yourself from getting drenched," Wood said.
While fixed expenses like rent/mortgage payments, power and food are accounted for in the budget, a rainy day fund puts money aside in-case things go wrong.
Saving purpose, amount and time-frame
The amount of money people need to stow away for emergencies is individual: for some, $2000 is enough, whereas others may need $5000 or more to feel secure.
As each person's income, expenses and priorities are different, there's no set formula for a rainy day fund, although Wood said for her, it's 5 percent of earnings.
"I tend to put 20 percent of my income away: 10 percent for long-term saving, 5 percent for a rainy day fund and 5 percent for charity," she explained.
Having decided on the required amount, getting into the nitty-gritty of how much to save and for how long requires people to decide on the little things they're prepared to forgo now, in return for feeling satisfied that their finances are under control.
Dave Smith, an accountant, said people with a natural tendency to live payday to payday will only feel motivated to change their habits if there's a powerful reason to save.
"Think of a few scenarios that have occurred, or that would get you into financial difficulty, and the amount that would give you that feeling of security," Smith said.
Common areas of unconscious overspending might include luxuries in the shopping trolley (e.g. fancy cheese, bottles of wine and convenience foods), fueling a daily espresso habit and buying lunch. But as with sticking to a diet or other personal change, success is achieved by cutting back rather than cutting out.
"If there's no room to curb incidental spending, consider making small changes, such as turning off lights when not in the room, and/or appliances at the wall to save money on power," Smith added.
Having looked at the reasons for saving, the sum required and the small, regular cutbacks that will go into the fund, behaviour is the driver to making it happen.
Little and often is the key
Small, incremental changes have a much greater chance of success than large cut-backs and the trick to changing habits is to keep the goal top-of-mind when making purchasing decisions.
"If cut-backs are too strict, you're less likely to see the goal through," Smith said
"Making small, achievable changes has the added benefit of changing the spending mindset, allowing people to save for bigger and better goals in the future," he added.
While more disciplined savers may save a rainy day fund by drawing down less on a revolving credit facility, having a separate savings account and seeing money grow can be hugely motivating.
The crux of a rainy day fund is to minimise stress and costs associated with running to fast credit.
"Emergencies do happen and by nature they're unpredictable.
"When under stress, [there's more of a tendency] to make irrational decisions, but with a plan behind you, there's no need to run to predatory lenders," Wood said.
The purpose of a rainy day fund is to have money at-the-ready to pay for a range of unexpected costs that aren't in the budget.
Deciding on the reasons for having one, the amount and the small, regular cut-backs that can be made, people will be in a much more powerful position to weather unexpected storms ahead, while creating sound financial habits that can be applied to bigger and better things in the future.
Newshub.
