Personal Finance

Debating the Rainy-Day Fund Amid a Downpour

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One idea that deserves to be rescued from the wreckage that is the California state budget crisis is the rainy-day fund. It may not be viable for an institution as dysfunctional as my adopted home state, where it's already pouring. But its principles have relevance for the rest of us.

This notion, championed by Gov. Arnold Schwarzenegger, was among five other fiscal measures that went to voters during a special election on May 19. Proposition 1A would have limited government expenditures by putting excess tax revenues into the aforementioned rainy-day fund. During the dot-com boom in the '90s, the state was flush with cash, but the Legislature spent it all. The Governator talked about the folly of this boom-and-bust cycle during a speech he gave in San Jose back on May 12:

"… every time the economy goes down, no matter who the governor is, (he) has to raise taxes. … So what we are saying here is let’s stop that madness. Let’s stop spending all that money when we have a revenue surge. Let’s put some of that money aside into a rainy-day fund so when we have a downturn in the economy that we have some money we can draw from."

I was listening to this speech on the radio at the time, and I thought it sounded not only plausible, but sensible. I voted for it when I scribbled out my mail-in ballot. But I was in a tiny minority. Prop 1A, along with every other measure (except a pointless one to cut raises for legislators during an economic downturn) was routed on Election Day. Only 23 percent of people actually bothered to vote, the lowest turnout of any state special election on record.

There are a myriad of reasons for Prop 1A's resounding defeat, a prominent one being its linkage to another failed measure, the education-funding Prop 1B; by itself, a rainy-day fund would provide no relief from the current malaise. California could become the first state to get rid of welfare; the idea of "excess" revenues anytime soon is laughable.

But the proposal raises an interesting question: Does a rainy-day fund make any sense at the household level when you're already soaked to the skin?  Experts differ on whether it does.  Personal-finance savior/scold Suze Orman has consistently hammered home the advice of paying off debt first, then building an eight-month emergency fund. But during the recession she's changed her tune: She now says you should pay only the minimums on credit cards and save up as much cash as you can in case you lose your job.

However, with money-market mutual fund accounts paying very low yields, other advisors say building up cash is a losing proposition because of inflation. "Letting fear dictate a cash reserve that's outsized," the people at Bankrate.com say, "is detrimental to your future financial health."

The young, particularly, could miss out on investment opportunities by getting timid, a 25-year-old WSJ blogger warns. And everyone should resist the temptation, however strong, to pilfer the 401(k) account, according to Motley Fool.

Here's the best advice I've seen: If you're going to build up a stash to wait out the next cloudburst, you might not want to keep it a secret from your spouse.

Landon Hall
– A freelance writer in Silicon Valley, Landon was a reporter, sports writer and
editor at The Associated Press in
Portland and New York City from 1997-2006.

  • Philip Parsons

    It’s a bone of contention when to use a rainy day fund, the mindset is to look for alternatives, when in reality it should be used now

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