Don’t Let Irregular Expenses Wreck Your Budget (or Drain Your Emergency Fund)

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:

1. 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.
2. 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:

1. Gather your expense history for the last 12 months.
2. 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.
3. Divide the sum for each category by 12.
4. 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…