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Savings tools to prepare for a rainy day

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The trick to saving for a rainy day is that you have to do it before the rains come…

That means putting short-term gratification aside (skip the extra latte, push of the vacation, put in more hours at work) in favor of the long term.

Investors understand this process as well as anyone. Putting money away long-term into a 401(k) or IRA means removing it from daily circulation. This seems much tougher to do in strenuous economic times, like today.

So, this tweet from Mint.com caught my eye yesterday:

So, I clicked through to find this interesting infographic.

It got me thinking about the right investing and personal finance tools to use to set up a rainy-day fund and how investors should approach this.

First of all, why set up an emergency fund?

  1. Sh*t happens: That’s just life. You need to have some extra funds on hand if you need to tap them for any of the things life throws your way (job loss, sickness, etc.).
  2. Avoid debt: Having some money set aside helps you avoid debt. That’s important in terms of the performance of your entire financial life.

How much to put in a rainy day fund?

  1. How much to put in an emergency fund: In The Wealthy Barber, David Chilton recommends keeping $2k- $3k in an emergency fund (it’s a more realistic goal for most people who have a hard time saving), though many others recommend more, like $5-$10k or enough to cover a couple of months of expenses. You want your rainy day fund to be new savings, not to liquidate longer term investment money (unless, of course, you don’t have a choice).

Here’s how I would begin setting up an emergency fund and managing it:

1) Set up all your accounts in Mint.com: Link up all your credit cards,  loans, bank accounts and investment accounts via Mint.

Here’s Aaron Pantzer, founder of Mint (it’s now owned by Intuit) describing how to use Mint.

2) Set up a rainy day fund as a goal: One of the most powerful functions Mint offers is the ability to set real-time goals for yourself. Create a goal of a specific dollar amount as your target (see above) and monitor your progress (Mint will show your goals in red or green depending on whether your successfully on target to get there). I’d try to get to your goal in 12-18 months, so divide your goal by 12 or 18 and save that much every month.

3) Make sure you set up email/text message alerts: So much of investing and saving is understanding our human working habits. We lose interest easily and get distracted. Don’t rely on logging into Mint.com on a monthly/quarterly basis to monitor your progress. Use Mint to set up text messaging or email alerts that will jog you into action.

4) Make your savings goals hurt if you don’t reach them: Sign up to Stickk. You can use this site (developed by Yale Professor Ian Ayres — listen to my interview with Ian Ayres) to commit to your goal of saving $x over 12-18 months. Set up your goal of creating an emergency fund and then set up “stakes” — put something on the line that would hurt if you don’t stick to your goals. Designate a referee, another person that can serve as a monitor of your progress and report it to Stickk. Lastly, you can define supporters (a public group of people — a spouse? good friend?) of people to help cheer on or scorn and mock you if you fail.

5) Set up automatic savings plans: The more you can automate in this process, the more you increase the likelihood you’ll reach your goals. Either in your brokerage account or bank, set up an automatic monthly deposit of the amount determined in #2. Invest it in a high yielding CD (a joke in this market) or a money market to just maximize the yield on it. Don’t invest it in risky investments — that undermines the purpose of the account.

5) Review, reset yearly: If you have kids or they move out or your lifestyle changes, how much you might need in your emergency fund might fluctuate. Review and reset at fixed intervals.

Mint.com is a very powerful tool — what do you use to create and manage an emergency fund?

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