Thursday, May 10, 2012

Re-evaluating Freedom Fund

One of the biggest things that has made it possible for me to be able to improve my personal financial situation is the maintaining of a freedom fund. A freedom fund is a different bucket of money that is used for clear and present expenses coming in the next 12 months. This is entirely separate money from your emergency fund.

The Emergency fund is some bucket of money that is set aside as insurance against loss of income for unavoidable expenses. When something happens and the income is lost, it is difficult to adjust lifestyle immediately. In fact, when you typically lose your income, there can be difficulty adjusting because you now have larger amounts of available time and this may coincide with some residual depression/anxiety resulting in an uptick in spending.

If you're anything like me, there are a series of expenses that you'd cut immediately if there was a loss in income. Then there are probably a series of expenses that you'd cut only if absolutely necessary. Then there are the absolute necessities.

When it comes to real costs and real inflation, the biggest problem usually comes down to pure necessities since all optional expenses are usually reduced or traded off and therefore considered highly elastic from the point of view of economics.

Essential expenses are the ones that cannot be avoided:

Food
Shelter
Heat
Clothing
Transportation
Medical Care

The emergency fund should handle the expenses for these categories for some period of time. For me, the emergency fund is a 1 year fund. That is, without any income, I could handle all of the essential expenses for a year.

Non-Essential expenses are those that would be easily cut: Services (haircuts, pet grooming etc.), cell phone, netflix, cable, entertainment, vacations. Obviously, this will be different for everyone.

Recently, I've realized that the amounts that were set aside for freedom fund and emergency fund were smaller than they needed to be for my intended goals. This is largely due to the fact that unemployment is lower in terms of the amount provided than expected and also because the amount of money for healthcare is larger than expected.

In the end, it means that about an additional 5K needs to be added to meet my goal of a 1 year fund. Furthermore, additional monies need to be added periodically in order to keep pace with inflation.

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