Monday, July 16, 2007

It has a name!

When I re-vamped my budget at the beginning of May, I decided that I needed to get better at planning for "unplanned" expenses. I had just been hammered by over $2,000 in car repairs, and a $1,400 income tax payment, and it was clear that I needed to start socking money away for these "surprises".

I had read plenty about emergency funds and their importance in a sound financial footing, so I finally took the plunge and opened an ING Direct account to begin building this safety net.

What occurred to me, however, as I made my first transfer into the emergency fund, was that not all expenses that catch me unprepared are actually "surprises". To be honest, in the past, virtually any "less-than-monthly" expense has found me scrambling. Despite the fact that our hydro bill is consistently $100 every two months, I always manage to spend the $50 per month that should be earmarked for the bill. Although Christmas and birthdays fall on the same day every year, I always end up paying for gift purchases on credit.

My solution to this was to open a second ING account, which I would use as my "periodic expense" fund. For each of these expenses that I had identified, I determined how much I needed to deposit each week in order to have the amount on hand when it came time to pay. For example, I estimated that I would have $500 in car maintenance every four months (hopefully, this is being pessimistic). Therefore, I decided I would need to deposit $125 each month in order to fund my maintenance needs. Vehicle registration is $75 every five years, so I would deposit $1.25 per month to fund this category. I repeated this for every category, until I had a total dollar amount that would be deposited each month. I essentially made this a "bill" that I would pay automatically at the beginning of every month, to ensure that I stick to the deposits.

I was very proud of this innovation. To date, I've made three months' worth of deposits, and have withdrawn only for gift purchases. Granted, it's still early days, but there's a great deal of comfort in knowing that, when it comes time to renew my passport or shop for Christmas gifts, I will have the necessary amount sitting on hand, earmarked for just that purpose.

Well, it turns out that this is hardly a new idea. Apparently, this fund is commonly known as a "Freeom Account". Michael at Money Musings is a strong advocate of this approach, which is championed by author Mary Hunt in her book "Debt-Proof Living". Michael even provides links to a really cool Excel spreadsheet that tracks the balance of the Freedom Account.

On the one hand, I'm disappointed that I'm not the first to come up with this approach. However, the fact that I did come up with the idea independently, and have since had it validated by other sources, is very encouraging, and makes me think that I'm really on the right track.

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