What is a rainy day fund?

Rainy Day Fund

The first and foremost target for anyone is to have enough liquid assets to constitute her ‘rainy-day fund’.

You should set aside the requisite money for a rainy-day fund in term deposits, low-risk fixed-income instruments or cash. If the rainy-day fund comprises of a small portion of higher-risk equity exposure, then such instruments should be highly-diversified. It should cover at least six months of expenses to deal with any unexpected emergencies (such as unemployment, illness) that might arise in your life as well as in your dependent family members’ lives. The rainy-day fund would also include six-month’s worth of any monthly payment commitments that you might be having towards mortgages, loans or insurance premiums.

You should not try to maximise the return-on-investment for your rainy-day fund. Instead, you should try to ensure that your rainy-day-fund is less risky and is liquid. The probability of your rainy day fund losing a sizable portion of its value should be low, and the probability of having a high volatility in its day-to-day value should be low.

If you specifically want your rainy-day fund to have an exposure to stocks, then such an exposure should happen through index funds. You should ensure that the rainy-day fund is highly diversified, and the proportion of stocks is minimal while the exposure to bonds is comparatively more. It is not easy to construct such a low-risk, diversified portfolio, and hence you may think to delegate this task by investing all or a part of your rainy-day fund with a digital investment management firm, such as our firm QuietGrowth, in a lower-risk portfolio. Given the modest size of your rainy-day fund, seeking the services of a high-quality human investment adviser for setting up and maintaining your rainy-day fund can be expensive.

In any case, just make sure that you keep a small portion of your rainy-day fund as cash. In addition to this, some people keep a small portion of their rainy-day fund as gold or silver that is easily accessible, and there is nothing wrong with it.

Only after you have sufficient money for a rainy-day fund, you should consider investing in a more risky portfolio, preferably a risk-optimised, highly-diversified portfolio for the long-term.

Note that a rainy-day fund can also be alternately referred to as an emergency fund. Some people try to articulate a subtle differentiation for an emergency fund, but please note that the overarching theme is the same.

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