J.D. at Get Rich Slowly discusses author Mary Hunt’s idea for the freedom account: an emergency fund in which you subdivide out amounts for specific intermittent expenses, such as car repair, wedding gifts, or expensive clothing purchases like shoes. The way J.D. describes it, you keep the money in a single checking account; then estimate your irregular, intermittent costs and keep a little log showing how much is dedicated to which purpose.
The basic idea is a good one. Trying to keep track of a bunch of different purposes for money accruing in a single account, though, strikes me as a giant pain in the tuchus. Also, even an ING checking account doesn’t earn enough to make it a good place to store money for long-term expenses.
Here’s a slightly different approach to the same goal of targeting your emergency savings:
Establish the categories in which you have intermittent expenses and identify the time intervals in which they occur: totally irregular, yearly, biannual, over several years. Then open separate accounts for these purposes. The length of the interval determines the kind of account you use.
For example, I look to the irregular little surprises that can happen at any time (plumbing or car repairs, vet bills, etc.), annual expenses (car and homeowner’s insurance, property tax, income tax), and long-term expenses (purchase of a new car, about once every ten years; major repairs or renovations on the house, which I hope don’t happen more often than about once every eight or ten years).
For the constant extra gouges, I have a money market account at the credit union. Into it I put $87 per paycheck–down from $200 a month since GDU’s shift to biweekly pay, because of the drop in net income that caused. When I have to cover an expense, I simply transfer the needed amount back to my checking account.
To pay my annual automobile and homeowner’s insurance bill, the annual cost of registering my car, and my annual property tax, I put $300 a month into a separate money market account, also at the credit union. I keep these funds physically separate from the day-to-day emergency funds because I can’t afford to have that money disappear: if I don’t pay my property tax, the house will be confiscated; if I don’t register or insure the car, the state will forbid me to drive it.
For long-term expenses, I use Vanguard funds: the Prime Money Market fund for major house expenses (reroofing, for example) and the Short-term Investment Grade Investment Corporate Bond fund for savings toward my next car. I plan to keep a car for ten years, so if I put even only a thousand bucks a year into that fund, what’s in there after a decade should be enough, combined with the clunk’s trade-in value, to buy another car in cash. Although neither of these is FDIC-insured, they’re both very safe (neither was exposed to subprime mortgage instruments) and they each earn more than I can make in a checking account. AND you can write checks on either of these funds. So it’s easily accessible when I need it.
When savings for specific purposes are collected in separate accounts, to tell how much you have for a given need, all you have to do is look at the bottom line. To my mind that’s a lot easier than trying to keep track of a bunch of separate theoretical subtotals in a spreadsheet.
2 Comments left at iWeb site
Some good thoughts.Thanks.It wouldn’t hurt to have more accounts open to help keep track of things.
Monday, May 19, 2008 – 07:22 AM
I have a similar thing going on as far as emergency money goes. I have a savings account at ING, and I also have several cash CDs there. I have one CD ($500 for 5 years) to stand as my auto insurance deductible. If I need to pay the deductible, there it is. If I don’t, it earns good interest and I have an incentive to not touch it (early withdrawl loses me 6 months of interest). I have a similar CD that is labeled “New Washing Machine” – our existing machine is rather old and I’d prefer to have money standing by to replace it. I’ll have to get some more CDs set up for car purchases – that’s a perfect candidate for laddering.
By the by, I choose cash CDs over money market specifically because of the withdrawl penalties – it’s that extra incentive I need to keep me out of them!
Monday, May 19, 2008 – 08:18 AM