Wednesday, January 23, 2008

Building a chequing cushion

I really have a feeling that 2008 could be the Year of the Loonie. I've set my formal goals for the year, but I'm also developing some informal projects as I go along. One of these is to pull myself further out of my paycheque-to-paycheque rut by developing a chequing cushion. I stated last week that I would be building up this cushion, so I thought I'd go into some detail as to exactly what this means, and how I plan to go about it.

What is a chequing cushion?

A chequing cushion is a sum of "extra" cash that I will leave in my chequing account(s). This money is separate from my Emergency Fund, but serves much the same purpose: it is meant not to be touched unless absolutely necessary. This will be useful under the following circumstances:
  • I incur a "temporary" expense, i.e. one for which I will be reimbursed. The cushion funds provide immediate access to the cash I need. For example, if I need to cover a medical expense, I can borrow the funds from my cushion until I file the claim with our insurance company.

  • I incur an unexpected expense. For anything that falls outside the scope of my regular bi-weekly budget or Freedom Account savings, the chequing cushion would be the first place I would look to cover the expense. If the cushion proves too small, then I would look to the Emergency Fund to close the gap.

  • Greater liquidity will give me more flexibility around my cash flow. Having cash on-hand, outside of my Emergency Fund, will allow me to "borrow from myself" to take advantage of opportunities (such as a sale on an already-planned purchase), or survive small crises (such as a delay in receiving my paycheque).
Essentially, this cushion will be looked at either as a temporary Emergency Fund, or as an extension of my formal Emergency Fund. The key to using this cushion effectively will be in training myself to know when my account is "empty", since there will always be funds in the account, even though the cushion is off-limits.

What is my ideal chequing cushion?

Ideally, I would like to have two weeks' expenses as a cushion, in addition to my formal Emergency Fund. This would mean that, without touching the Emergency Fund, I have two weeks to respond to any disruption of my cash flow. When I reach this point, I will know that, if my pay is delayed, or an expense comes early, I can cover it without depleting my Emergency Fund.

How will I get there?

Two weeks' expenses is not a neglibible sum, and it will take a while to get to that amount. I've divided the target into some different "segments", in order of their priority:
  1. Ms. Loonie's expenses - I've already discussed the fact that Ms. Loonie and I approach our credit card payments differently, and I really want to get her ahead of the payment cycle. Therefore, the first priority is to save up one month worth of Ms. Loonie's expenses, in order to get her in sync with my own pay-as-I-go approach. We'll work together to determine exactly what this number should be.

  2. My discretionary expenses - Once Ms. Loonie's expenses are covered off, I'll focus on building up enough to cover my discretionary spending, which includes wardrobe, gifts and "fun". This may seem counter-intuitive, but I'm taking a page from Dave Ramsey's book here, by tackling the less important, but more achievable goal of discretionary spending first, and then moving on to my committed expenses. Obviously, in the event that we hit a major bump in the road, the committed expenses will be given first payment priority, but while I'm building up our cushion, I want to be able to check steps off the list, to mark my progress.

  3. My committed expenses - Once I've got my discretionary spending covered, I'll build the cushion up to the final stage of being able to cover all of our committed expenses, including mortgage and other debt payments, groceries, etc.
As to how long this will take, that will depend on the exact amount that we decide on. The saving approach is basically a savings snowball, where my progress will accelerate as I get closer to the goal. It will be a long undertaking, but it will provide significant peace of mind. This is all about forward progress, and knowing that I'm in a slightly better position with every bi-weekly contribution will be a huge motivation.

Do you keep a chequing cushion? How have you gone about setting it up?

1 comment:

Canadian Dream said...

Good post. I used to keep a chequing cushion for a number of years of about 1 months worth of expenses.

Now that I've got a better understanding of cash flow cycles I've stopped having it. Instead I keep the extra money in our high interest savings account.

It's a good thing to have until you sort out how things work best for you.

Tim