Almost every financial planner will tell you that you should set aside money for a rainy day. It’s like a golden rule that you must have a rainy day fund. Some advisors say 3 months income, others 6 months. Some even say a year’s income should be stored in cash or cash-like savings just in case you lose your job, have a massive car repair bill, a dead fridge, or you suddenly need to go on a trip to Belize.
Fortunately I’m not a financial planner so I can say whatever I want and I’m going to tell you that unless you’re in a very special circumstance you shouldn’t have a rainy day fund.
Rainy day funds enable random trips to Belize
I’m sure you noticed that one of the emergencies I just rattled off was kind of different. To paraphrase high-quality children’s television, it just wasn’t the same as the others. Look, I’ve got nothing against Belize but the first thing you have to realize about yourself is that when given a large quantity of cash you’re very likely to spend it either on a big stupid purchase or many small stupid purchases. Maybe you’re the one person who absolutely won’t under any circumstance succumb to the immense pressure of a lump of cash equal to several months of income. Don’t lie to yourself, you’re probably not. You’re probably thinking “Dean it’s my savings, I can do what I want.” Sure. Just don’t lie to yourself about your real motives— call it savings for a random trip to Belize, not an rainy day fund.
Where should I put that money instead?
Put that rainy day fund money on debt. Mortgage, student loans, car loans with a rate more than 0%, credit cards, whatever. We’ve already established that the over-arching financial goal of a person is to maximize their net worth. I’ve given you some steps to do that. This is just another one: the interest you’ll earn on that sum of money in liquid short-term savings is less than the interest you’ll pay on the debt you owe. If you owe anything (including unused TFSA and RRSP contributions) pay that off before you go saving cash for dead washing machines or theoretical job loss. You’ll earn a higher after-tax rate and increase your net worth faster.
Put yourself in a place where emergency cash is available when you need it
The thing about the society we live in is that credit is cheap and plentiful. Lines of credit are great power with great responsibility and this is one circumstance where a line of credit is a great idea. Get a line of credit at the best rate you can find, preferably one a limit of two or three months income. Then leave it at a $0 balance for a rainy day— a REAL rainy day. If you already have a line of credit and it’s maxed out, pay that off as priority number one.
Isn’t that the same thing as saving an rainy day fund?
Why is a line of credit a better idea than a positive cash balance? You will not treat them the same way. Sometimes you have to socially engineer your financial life to protect your money from yourself and this is a perfect example. You’re more likely to not use the money to buy stupid things if it will put you directly into debt than if it would just decimate a positive balance. The thing is, decimating that positive balance is putting you into debt just as badly because all other things being equal you’re actually paying more interest on your debt than you’d earn in the cash account, remember? And you’re for sure paying that interest as opposed to possibly paying that interest in the event of an emergency.
Job loss sucks, I understand. Many if not all of us will experience some period of unemployment at some point in our lives. I’m not advocating going into debt when you lose your job, either. Fortunately in Canada we have quite a good employment insurance system. If you’re already living within your means (saving a lot of money for retirement, paying off your mortgage quickly, owing little or no debt that isn’t being accelerated), then you can stand to dial back the mortgage payments, axe the savings and subsist on pogey for a bit while you search for a new job. And if you do get more debt in the process, you’ll be better off having paid it off more aggressively and starting your unemployment with less burden than having a pile of cash that will largely be used to service existing debt.
Your car and house are paid for. Your TFSA and RRSP are maxed. You have no debt to speak of and you’re living within your means. Congratulations, you are a candidate for a rainy day fund. But in this case, why? You’ll earn more money investing it than keeping it in cash. And the alternative, blowing it on a sweet trip to Belize, is a lot more fun. Both seem like good options for you at this point.
Man, you’re stingy!
No, I’m honest and you should be too. I’m not saying don’t go on trips or have fun. I’m saying that having a rainy day fund as a structural part of your finances is generally a lame idea.