Last month, in our quest to help you along your financial journey for 2012, we highlighted the importance of spending on what you need. Today, we focus on the critical need of planning for a rainy day.

Into every life some rain must fall

Even when times are good, people can face sudden financial crises such as appliances that stop working, a job loss, a long illness or an accident. In uncertain times like today, it makes extra sense to safeguard yourself against unforeseen eventualities and interruptions to your income.

Building up a “rainy day fund” is the best way of giving yourself a cushion and stopping a drama turning into a crisis. “Rainy day” money is cash that is not tied up in investments and which you can get at a short notice.

Why should this be a priority now?

The current cost of living makes it tempting not to put money aside. But if and when that rainy day comes, without an emergency fund you could be as good as broke. Remember, even expected expenses become emergencies when you don’t have the money. 

Not preparing could cost you more later

If you don't have any money set aside but own investments or other valuables, in a crisis you may be forced to sell some of these to take care of urgent needs – and to do so at a throwaway price. Or you may have to borrow at exorbitant interest rates, entering into debt which can take many years to pay off.

A stitch in time saves nine

If you don't have any spare cash and are living paycheck to paycheck, you could be just one blown car transmission or one dead tire away from bankruptcy. Putting even a little money aside bit by bit in a rainy day fund can stop difficult situations from becoming a crisis. 

How to build a fund

First decide how much you need. Start with a specific savings goal in mind. This will depend on your income and expenses but a general rule of thumb is to save so you have enough to cover four to seven months' worth of expenses. Many people aim for a $10,000 fund as a start. After all, in an emergency, you won't need money for vacations, fancy new clothes, dining out or other luxuries – those are not emergencies. If $10,000 seems daunting, shoot for $1,000 and work your way up to a reserve that covers at least two months' worth of expenses. 

Then treat savings like a bill. Make a monthly savings goal part of your regular budget. Set up an automatic monthly transfer (standing order) from your paycheck, in the same way you might pay for your electricity by direct debit on the same day of every month. This will help you build your fund steadily. 

Furthermore, ensure you are saving the right amount. Too many people put more money than they can afford into savings accounts only to pull it out to pay routine bills. A realistic monthly spending plan helps avoid this.

Proper planning also stops you abusing the rainy day fund by using it to pay for predictable, once-a-year expenses such as household or car insurance. You can foresee these, whereas the fund should only be for expenses you cannot foresee. 

Where should you set up your fund?

Your rainy day fund should be easily accessible, but not so easy that you're tempted to make withdrawals for everyday spending or to use it for predictable non-emergencies.

Open a savings account away from your normal checking account to build a psychological wall between your spending habits and the emergency fund. Credit unions are good because they allow you to start with smaller deposits on interest-earning accounts.

Finally, keep the fund topped up.

Once you have used some of your fund and the emergency is over, make sure you replenish it without delay. Click to learn more about saving, budgeting and spending.