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Why You Need a Rainy-Day Fund

Learn how a rainy-day fund differs from an emergency fund, and how it ranks compared to paying off debt.

When it comes to personal finance tips, there's a lot of advice out there. A good chunk of it is common sense—don't spend all your money at coffeeshops and bars, try to live within your means, save where possible, splurge only when you can afford it, etc. — but some of the finer points of responsibly enjoying financial independence and working toward various financial goals, like the difference between a rainy-day fund and an emergency fund (and why both are important), can easily get lost.

What's an emergency fund?
Building an emergency fund is a big talking point for personal finance: The emergency fund is the financial cushion that can keep you afloat if you lose your job, are in an accident or are otherwise unable to work for an extended period of time. Emergency funds are typically rather large—the standard recommendation is to save three to six months of expenses—and often overshadow their smaller counterpart: rainy-day funds.

How does it differ from a rainy-day fund?
An emergency fund is intended to cover standard living expenses; a rainy-day fund is for surprise emergencies, like a pipe bursting in your kitchen, a pet suddenly getting sick or your car breaking down. An emergency fund keeps you afloat during extended periods of financial difficulty, and a rainy-day fund gets you through a short crisis or one-time incident without going into debt—and as such it should be everyone's first priority once they start supporting themselves and making money.

Should you pay down debt or build a rainy-day fund first?
"I very strongly believe that the rainy-day fund or the financial safety net, the one that we would say is equivalent to one month's worth of expenses, is going to take priority, even over paying off the high-interest-rate debt," says Lauren Anastasio, a certified financial planner at personal finance company SoFi.

Putting away any cash savings may feel unglamorous or impossible, especially for those facing high-interest debt, but it needs to be prioritized. It may seem counterintuitive, but reducing debt payments enough to make tucking away one month's worth of expenses possible can actually make it easier to stay out of debt in the future.

What often happens, Anastasio says, is that people will work hard for months to pay off high-interest debt (think credit card debt or a high-interest personal loan), choosing to put money toward reducing that debt instead of into savings. They pay off the debt, and—as it tends to do—life happens, and their car breaks down or they have an unexpected medical bill. Without any kind of savings to fall back on, these people may have to pay to fix the emergency with a credit card and fall back into debt, undoing all their hard work in one fell swoop.

"They're devastated because they've worked for so long to try to pay [debt] down, and the cycle just started all over again," Anastasio says. "So making sure that that fund is there is really one of the things that helps ensure their success in their efforts to pay down that high-interest-rate debt."

The bottom line
That rainy-day fund doesn't have to be much—any savings is better than no savings—but tucking away just a small sum of cash before focusing on paying down high-interest debt can mean the difference between staying out of high-interest debt and falling back into it when catastrophe strikes.

Prioritizing financial moves can be tricky, but Anastasio's advice is to establish a small rainy-day fund, then pay down high-interest debt, then decide between saving for retirement, building an emergency fund or tackling another financial goal. Everyone's financial situation is different, but for the vast majority of people, the rainy-day fund should be a priority.

"Having it there is going to make it so much more likely that [you're] able to accomplish other goals," Anastasio says.