Don’t Let Irregular Expenses Wreck Your Budget (or Drain Your Emergency Fund)
Published on - December 15th, 2009 (by April Dykman) This post is from GRS staff writer April Dykman.
Right before our Thanksgiving trip, the AC went out on our vehicle. $600 later, we had a functioning AC. What a way to start a camping trip.
The good news was that we had the funds set aside for that specific reason—auto repairs. We’ve never used one of our targeted accounts before, and now that we have, I can attest that they are a fantastic idea.
Obviously the repair would cost the same whether it came from a big account labeled “emergency fund” or a targeted one called “auto repair.” We’re out $600 either way, so why bother with separate, targeted accounts?
Two reasons:
- By paying from a targeted account, the three-to-six months emergency fund (EF fund) isn’t tapped. We look at the EF as money for major or unforeseeable expenses only.
- Paying for repairs is never a joy, but it’s easier when the money was there for that purpose.
It’s extremely easy to set up targeted EFs, and they’ll save you a great deal of frustration and headaches when faced with irregular expenses.
Step one: Calculate a reserve for targeted EFs
Once you are free of consumer debt and have a comfortable EF, start creating targeted EFs for expenses that are inevitable, but irregular. For example, we have a savings account for property taxes. That’s a regular, yearly expense we can count on having to pay. We also have a good idea of exactly how much we’ll pay. A targeted EF is different because it’s meant for expenses that will hit at some point, but you don’t know exactly when or how much you’ll have to pay.
Here’s how to start creating your targeted EFs:
- Gather your expense history for the last 12 months.
- Calculate how much you spent on irregular expenses, such as car maintenance, medical bills, and home maintenance. You’re looking for expenses that you know you’ll have at some point, it’s just a matter of when.
- Divide the sum for each category by 12.
- Save those amounts each month to build up enough savings to handle the expense. Or, if you don’t have that much room in your budget, save up what you can in each category until you hit your reserve target.
Make sure you don’t confuse the purpose of your accounts. Saving for a car is not the same as saving for an auto repair for a vehicle you currently own. That said, try not to create too many targeted EFs. Make the categories broad, if needed. We only have two targeted EFs right now, and we’ll add a third for home maintenance next year.
Step two: Create sub-accounts
My favorite method for targeted savings accounts is creating multiple accounts at ING Direct, which I learned about here at GRS. Other banks probably offer similar setups. As you set up each account, label it for its specific purpose.
Bonus points: Automate it
Put your savings on autopilot to avoid the temptation to spend the money elsewhere. We started our auto repair savings account by setting up automatic deposits of $100 per month. In no time the account was big enough to cover our recent repair.
This is not a perfect method. Just because we only spent $600 on auto repairs this year doesn’t mean we won’t have a $1000 repair next year, but at least some money will be saved up to help cover the expense.
Peace of mind
One last benefit I want to mention is that when you’ve already predicted and accepted that you’ll have these irregular expenses, and you’ve set aside money for them, it is less aggravating when they occur. If we had to pull money from our three-to-six-month emergency fund, I would have started off our trip thinking about how quickly we could replace the funds, and where we could cut back to do it as soon as possible. Or worse, if we didn’t have any savings to cover the repairs, we’d be scrambling to figure out how to pay for it. Maybe we wouldn’t be able to go on the trip. Instead, I left feeling relieved that the money was there and a car repair didn’t blow our budget.
Peace of mind isn’t a tangible benefit, but to me, it was the best one of all.
Do you have separate accounts for irregular expenses, or do you have one big emergency fund?
J.D.’s note: As I write The Book, I’m amazed at how often I refer back to the idea of targeted emergency funds. I find them useful in Real Life, too. It’s so much less stressful to pull from your home-repair fund to fix a leaky roof than to drain your main emergency fund…
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“Tyler Karaszewski Says:
December 15th, 2009 at 9:27 am
I feel like excessive budgeting is the equivalent of auto enthusiasts putting vinyl graphics or big spoilers or “cold air intakes” on their cars. They don’t really *do* much, but they’re relatively easy and inexpensive and they make you feel like you’re participating. You’re now a “tuner” because you did something to your car, even though it’s not any faster than it was. Same with personal finance — you’re now participating because you put labels on everything.
Whether you pull $600 from a larger emergency fund of from a separate car account makes very little practical difference. You’re probably better off spending time learning a skill that will increase your income or looking for a better job than you are wading through personal finance spreadsheets and perfecting your targeted accounts.
I essentially have a “money for things I might want or need” account. It’s my checking account. I try to keep a few thousand dollars in there for things I might need. Recently I had to pay a $1000 vet bill. Where did the money come from? It wasn’t in a “pets” account — it was in my checking account. I’m about to take my wife’s car in to get the timing belt replaced ($700). Guess where this money’s coming from? My checking account. This works fine — at least, I have yet to end up on the street using this method.”
Well said. Whether it is in a checking account or savings account the point is to have a large cash reserve for expenses, both planned and unexpected. That said, to each his own, but I would note that there are significantly opportunity costs to the ING sub-accounts method. Rewards checking accounts as someone already mentioned provide a superior return (3-4%) so at some point you have to wonder if it is worth it.
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I do have several targeted accounts, even if some of them are just in an envelope. My only problem is; I’m willing to spend a little more than warranted just because the money is there. I don’t try to cut costs so much because the money is already budgeted for this head.
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I come down in the middle here – don’t want to spend the time setting up too many accounts, but I know how much comes up in irregular expenses on a yearly basis (car insurance, Christmas, property taxes, house insurance, etc) and every month 1/12th of that goes into a planned spending account. Then I have long term savings (=emergency fund) and a dream fund (long term things we want to do to save for). Retirement savings are completely separate. There’s stretch room in our monthly budget, so car repairs, etc, come out of that and we spend a little less in some area if something like that comes up. Lets me relax that nothing other than a major emergency will come up that can’t be dealt with, but doesn’t take time to keep track of. And it lets me easily see how much for dreams and where the EF is at, without doing the double-counting on the planned spending account – that one doesn’t even get included in my calculations of how much is saved because it will all go out over the year.
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We have only one large ING account for emergency funds, however, I keep a spreadsheet of annual expenses that are housed there (Home owner fees, annual insurance premiums, Christmas presents, vacations). It’s easier for me this way since I can use the Excel spreadsheet to “play with the numbers” when I need to make adjustments. Instead of pulling the money from the emergency fund where it’s “earmarked” we try to go ahead and pay for it with our regular funds. If we’re able, then we can shift money earmarked for insurance to vacation instead.
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No question this strategy adds a lot of stability to personal finance planning.
Beyond our EF, we have a fund for 1) home repairs, appliance replacement, taxes, insurance, dental, etc … 2)tuition (I’m woking on my doctorate) and last but never least 3)Vacation.
I divide the accounts up in Quicken. Works beautifully.
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I have lots of targeted funds. The main thing I do differently from this post that no one has directly talked about is that I don’t calculate a reserve. I do calculate a monthly amount to contribute but not a reserve target. There’s no point at which I decide there’s “enough” in the account. I will adjust the monthly savings from time to time and I will sometimes transfer money from one account to another.
@Sandy L #80 (or others), how did you calculate the “average life” of your breakable stuff?
@Tyler #64, nice point. I am one of those people who thinks she’s living below her means but is actually accounting for every dollar. If I suddenly had a pay cut, it would be a bummer and I would have to adjust at least some of the categories downwards. Every time I get a raise, I increase a bunch of the categories to account for inflation and then decide where I want the remainder to go.
It’s hard to imagine doing it any other way, though. Your extra money is still there and has a use. You describe this as “This money has no purpose. I can use it to pay my vet bill, or a car repair bill, or buy myself new toys, or waste it on something that turned out to be a dumb decision.” I think this is how I use my “long-term fun” category. It’s supposed to be for fun things that are too expensive to pay for in a single month, but I can also easily raid it in case I didn’t budget enough in my other categories.
But actually, I think I’m currently putting all my excess funds into Roth retirement accounts, and I do like doing that. So I’m going to keep living at my means, but it was good to think about.
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personally i would rather estimate the annual irregular expenses, and lets say it works out to about 2 months worth of your salary, simply add this 2 months extra savings required on top of my emergency fund. essentially it becomes one big emergency fund. i can think of 2 benefits:
one, i find it easier to manage and track a smaller set of personal bank accounts. less paperwork, less pin numbers to remember etc.
two, if you were to set aside your emergency fund in a money market account, pooling the sums may help to generate greater returns and incur lesser commission.
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I have a LOT of targeted accounts and we are adding more. We are so very good at not spending money in a targeted account. And we are so very bad at spending money needlessly when it was all jumbled together in one account marked “irregular expenses.”
It’s not complicated in my head to have 30 sub accounts (or whatever) cuz on the 1st of every month, all bills get paid. Then on the 2nd of every month, everything is automatically transferred to the sub accounts and we pull cash out for the month for spending money and groceries. There’s no work involved to me.
In January, for example, you pay with your debit card the $16 copay for your dental checkup. When you get home, you transfer the money from the targeted account to the checking account. Or you call the bank on the way home (so you don’t forget) and they transfer the money for you. If you do forget, it’s a 3-dollar insufficient funds fee at worst (We have a fabulous credit union). Once you get into the habit, it’s a no brainer. If you have a smart phone, while you’re still in the dentist’s office, you can transfer the money then and there. Or if you know what the bill will be in advance, you can transfer the money ahead of time or schedule an automatic transfer to occur that morning if you’re concerned with spending it if it is in the checking account.
I have no discipline with credit cards so i’d rather make a transfer each time we have an irregular expense than overspend on a credit card. I don’t EVER want to tempt myself again with credit cards. And when i transfer the money from the targeted fund to the checking, I take that time to be grateful that I have the money and that I’ve figured out a system that works for us. So it’s not really work for me. And it’s not like you have an irregular expense all that often (like 3 times a day or something).
Everyone’s comments are really interesting.
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I don’t because I decided until I get my CC’s paid off, it doesn’t make sense to set extra money into savings beyond my (baby) emergency fund at 1.XX% interest. I do average the expenses such as auto repair out over 12 months, but whatever doesn’t get spent that month goes to the CC debt. If I do have to tap into my EF to cover these kinds of expenses, then the extra goes toward building the EF instead. I am looking forward to the day that the extra goes into targeted savings instead!!!
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At first, I liked the idea of budgeting for individual spending accounts as you mentioned, but the more I thought about it, the more I decided that one large emergency fund still works best for us.
First, and foremost, by dividing your savings, each individual “safe” amount is achieved much more slowly. For example, let’s assume I have a car repair account, a house repair account, a medical expense account, and one for other general emergencies, and that I am able to contribute $200/month into the emergency fund as a whole. For simplicity, I will divide the money evenly, and each account will get $50/mo. But, if after 6 months, I have the $600 repair bill you mentioned, I only have $300 in the vehicle repair account, so where does the rest of the money come from? Eventually, any of the accounts are fair game for withdrawing money in the event of an emergency.
For that reason, my wife and I decided to create one large emergency fund in lieu of multiple smaller ones. While we have not yet fully funded it, our eventual goal is to have 1 full year of estimated expenses in liquidable funds (CDs, cash, etc). By using the term estimated expenses, I am calculating the amounts we would portion into those separate accounts, and adding that to our regular annual expenses. Obviously this is a long term goal, but the way we see it is that until that point, it doesn’t matter anyway, because the funds will come from the same place in the event of an emergency.
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Gosh, I’ve been back and forth on this issue for the last month. After re-evaluating things some, I thought it might be a good idea to create a bunch of separte accounts for vacation, taxes, etc., so I did. I thought that perhaps psychologically it would seem like I was better prepared for upcoming expenses.
Turns out, after just a few weeks, it was driving me insane…way too anal for me. I also can get 4.26% in my checking account, so why on Earth would I separate money up into a bunch of ING accounts earning 1.3%? For 20 years, hubby and I have had success with keeping a larger saving account all in one place and opening CD’s every so often. Until I see a CD for over 4%, my money will stay at NBRS at 4.26%. I have instead set some lofty savings goals for the next year, and am going to be putting my financial energy into these goals rather than having a bunch of separte accounts.
I think both systems work great, depending on your personality. IMO, the important issue is ARE you saving, not the details of how many accounts one has.
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