Savings Accounts and Rainy Day Fund
A savings account is a depository account that allows you to store your money and earn a small amount of interest, generally 0.5% to 3%. The bank will use the money you place in the account for banking purposes and will pay you back a small amount of money (known as interest) for the privilege of having used your money. The amount of interest you receive will vary according to the prime rate set by the government but will typically be very low. Because the interest you earn is so low, a savings account is not a very useful investment vehicle.
So, what is a savings account good for? Besides allowing you to store your money in a safe yet accessible location, savings account balances are insured by the Federal Deposit Insurance Corporation (FDIC) for up to $250,000 per account. This is a federal corporation that makes sure that any money you deposit is not lost even if that the bank goes out of business.
Although the bank uses the money you deposit in a savings account for banking needs, your money is always available to you. You can withdraw your money via automatic teller machine (ATM) or with a bank representative (teller). You can even withdraw money electronically from a savings account and have it transferred elsewhere.
Banks will offer a variety of savings accounts. Some accounts require you to maintain a minimum balance each month in order to avoid incurring a fee. Other savings accounts are completely free. Investigate your options with the banks in your area.
Rainy Day Fund
Another way to use a savings account is as a place to store your emergency reserve or rainy day fund. Your rainy day fund is a safety net you should save up and keep on hand for use to sustain yourself in the event of an emergency such as a job loss, catastrophic illness, or death in the family. Your rainy day fund should be large enough to cover at least 6 months of living expenses (as opposed to salary). If it costs you $2000 to pay your living expenses each month, you should save up $12,000 for your rainy day fund. This figure may be even larger than 6 months of your salary if your income is low.
For most people, your rainy day fund will end up being a relatively large sum of money. It can seem impossible to save that much money, but it is actually very simple to do so. Simply begin saving between 10 and 20% of your gross (pre-tax) salary. Every time you are paid, figure out what 10% (or more) of your check is, and move that amount into your savings account or employer savings plan. Do this before you pay any other bills. After a period of time, you will have enough money in your rainy day fund to cover 6 months of your expenses.
The general guideline for deciding how much to save is that you should save at least 10% to be comfortable. If you would like to have more than a comfortable savings fund, you will need to save 20% or more.
Because a rainy day fund is such a large sum, many people do not think they can save that much. Anyone can save money, however. The key to saving money is understanding that you are working to support yourself, not to pay bills. Thus, you must learn to pay yourself before you pay your bills. So many people are caught up in the notion that bills come first. They pay their mortgage/rent, utilities, and credit cards but find that there is very little left for their savings. You must understand that the credit card company will not send you a check when find yourself retired with no savings and no investments, nor will your creditors (the people you owe money to) come to your aid if you have a financial crisis. If something bad happens, you will have to be in a position to help yourself out. You can do this by making saving a priority. If it helps, think of saving as the very first and most important bill that you need to pay each month. Once you get accustomed to thinking this way, you will not even miss the money you put aside. You will adjust to living on what is left over after you make your savings deposit. This is not to say that it is okay for you to ignore your bills. On the contrary, you need to pay your bills and maintain good credit. You simply should not sacrifice your savings goal in the name of paying bills. Savings comes first, and paying bills comes second.