Last Friday's post comparing Canadian financial terms to their American equivalents certainly seemed to be popular. I've added a link to this post in the sidebar, and I think I'll update the post from time to time as needed. Thanks to everyone who commented, and thanks to my new RSS readers.
I've had some comments recently on the specifics of my Freedom Account, so I thought I'd take some time to go over how I use this account, and how I went about setting it up.
Why a Freedom Account?Everyone has recurring expenses that come up every few months. Cars need tune-ups, licenses and passports need to be renewed, and birthday gifts need to be bought. Because these expenses are so far apart, many of us tend to assume that we'll have the money on hand to pay for them when they occur. However, unless we're extremely disciplined, these expenses still manage to catch us unprepared, and more often than not, we end up either using credit to cover them, or calling them "emergencies" and dipping into our Emergency Fund (if we have one).
The Freedom Account is essentially a place to plan and save for these expenses, so that when the bill needs to be paid, the required cash is available, and ready to be spent guilt-free.
What expenses do I save for?The short answer is, any recurring expense that occurs less than once a month. To answer this question, you need to know your expenses. Create a list of your categories of spend that meet these criteria. For each category, note the number of months between occurrences, and the amount of the expense each time it occurs. Here's a sample of some categories from my list:
- Vehicle service - $500 every 4 months
- Vehicle registration - $74 every 12 months
- Driver's license renewal - $75 every 60 months
- Passport renewal - $89 every 60 months
- Christmas gifts - $840 every 12 months
- ... etc.
How much do I save?Take the list of categories you created above, and divide the amount of the expense by the number of months between occurrences. This becomes the per-month amount that you should set aside for this expense. For example, with my $500 every 4 months for vehicle service, I would set aside $125 per month for this category. Add up the per-month amounts, and that's the total amount that you should transfer to your Freedom Account at the beginning of the month. If you make this transfer automatic, then you can simply forget about it, and know that the cash will be there when it's needed. In four months, for example, you'll have $500 saved up for vehicle service. In 12 months, you'll have $840 saved up for Christmas shopping.
How can I super-size this strategy?If you take the per-month amount calculated above, and save half that amount every two weeks, then you'll end up saving an extra month's worth of Freedom Account contributions each year. You can use this money as a cushion in your Freedom Account (earning interest, of course), or you can use it to add to your Emergency Fund or pay off debts. It's your money, so put it where it's needed.
There are a few things to keep in mind with the Freedom Account:
- Review your categories. When you first set up the Freedom Account, you will be using rough estimates for a number of the categories. Every few months, do a review of your spending, to see if there are any new categories that need to be added, or to change the per-month amount in some categories.
- Keep track of your withdrawals. In order to use the Freedom Account effectively, you should know how much cash is available in each category. You don't want to hurt one category in favour of another, so pay attention to how much you've spent.
- You may have some shortfalls early on. I started contributing to my Freedom Account in May, and had to renew my driver's license and vehicle registration in August. This meant that I only had $30 saved toward this $149 expense, so I was still out-of-pocket by $119. However, the next time these expenses come up, these categories will be fully funded, and I won't miss a beat.