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Why You Need Both a 'Rainy Day' and an Emergency Fund

Here's how much to set aside for those surprise expenses — big and small

If you found yourself suddenly out of work, a hefty emergency fund would give you peace of mind, because you'd be secure in knowing that, despite your economic setback, at least you'd be able to pay your bills.

An emergency fund also gives you the freedom to make personal choices that you can't make when you're cash-strapped. For example, many people build up sizeable emergency funds in order to cover their living expenses once they decide to pursue personal or professional goals, such as going back to school to earn a degree or quitting a job to launch a new business.

Regardless of your financial situation, everyone needs a rainy day fund and an emergency fund. If you have no savings, you should make a commitment to saving money regularly. Over time you'll create both funds that you can depend on when they're needed.

To build up your emergency fund, start with small contributions of perhaps $25 to $50 per month. If you can comfortably afford more — maybe $100 to $200 a month — strive for that in order to more quickly amass the savings you need.

Make the process of saving hassle-free and systematic by having money taken from your paycheck or checking account and deposited automatically into your emergency fund. Saving 10 percent of your salary is a good target. But if you can't meet that goal, even saving 3 to 5 percent of your annual income will be very beneficial.

It's also a smart strategy to use financial windfalls, such as income tax refund checks, to boost your funds.

As you build both your rainy day fund and emergency fund, keep the cash in an interest-bearing savings account or a money market account. You don't want to put this money into a CD or mutual fund because you'll need to have ready access, and you don't want to pay taxes or penalties when you need it.

Lynnette Khalfani-Cox, The Money Coach®, is a personal finance expert, television and radio personality, and a regular contributor to AARP. You can follow her on Twitter and on Facebook.

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