Thursday, August 02, 2007

Emergency Fund Strategy

In terms of building an emergency fund, I've found that the "freedom
fund" strategy seems to work best for me. Although I keep almost all
of the savings in the same high-yield savings account, I allocate it
to different buckets.

Each year, I consider what the "big" and "unexpected" expenses will
be. This could be weddings and holidays, vacations, tax bills, etc
that will have to be paid throughout the year. If I am unsure, I look
at last years bills and inflate the total by a few percent. Then I
round up a little bit.

So, if I ended up with a total of 189/month would be needed, I'd make
my goal 200/month saved for these kinds of expenses. Then when they
come up, if they are less than that month's 200 dollar deposit, I just
take it out of that month's deposit. If it is more, I withdraw the
difference from the account. And if it is less, I deposit the
difference into the account. The whole time, this money is sitting in
an account that makes a nice interest rate.

The nice thing is the interest I'm making. Since these bills happen
fairly regularly (every month or two), the money is somewhat short
term. But for the short term, I make interest on the money that is
then applied to my "emergency fund". All of the interest from the
high-rate account funds my emergency fund.

This is a sum of money that I keep aside, never to be touched except
in a real emergency like a job loss, medical emergency, natural
disaster, fire etc. Currently, my goal for this fund is to have 3
months of expenses in this risk-free savings account. That, combined
with other savings and "freedom fund" money (also in that account) and
curbed spending in the face of an emergency could easily get me
through 4-6 months and I'm comfortable with that.

Once all the goals are met and debts are paid down, the goal will be
to create a fund for investing. Debt reduction will be a major
component of what happens with my finances for the next several years,
however, since I still carry a large student loan debt load. It was
money well spent, but I intend to continue to seriously attack the
balance so as to reduce interest payments over the life of the loans.

In addition to my "freedom fund" deposit, I also deposit a small token
of money into the account that I apply only to my emergency fund
target so that I always can be sure that this goal is being worked
toward. Here is a percentage breakdown of how I manage.

Emergency Fund:
1% of monthly income (deposited)
.05% of monthly income (interest)

Freedom Fund:
3% of monthly income (deposited)

The nice thing is that by having both a "freedom fund" and an
"emergency fund", you don't have to worry as much about the emergency
fund because you've already handled most of your major "emergencies"
in your freedom fund.

Categories in my freedom fund include:

Car Expenses
Excise Taxes/Water Bill
Christmas
Clothes
Entertainment
Vacation
Home Repair
Medical/Dental
New Car Down Payment

1 comment:

Brip Blap said...

That's an interesting way to look at it. It's probably good to have an emergency fund and a "not exactly an emergency fund". You could categorize the two many different ways: long term and short term, big and small, etc. But it's a good way to think about preparing for all possible 'emergencies', since having one large fund might lead you to be unprepared for a true significant life emergency.