Do you know what a Freedom Fund is? Have you heard of it before? Any ideas what it might be?
No.
Well, you're not alone. I hadn't heard of one either until the other day. After a bit of poking around, I present a short article on what a Freedom Fund is and how you can use one.
Covering your Backside
Every month you get paid (maybe every two weeks, but just go with me for a while). Every month you have regular expenses. Your mortgage/rent, your electricity, your phone and maybe you pay your insurance and a few other things monthly too.
Then you have some of those irregular expenses. Maybe your car tax is a once or twice a year thing. How about other insurance which is once a year. What about a magazine subscription or even an on-line service you use which is due this month.
These irregular payments are a complete pain in the backside. I know this. You know this. Everybody knows this but not everybody knows how to deal with them.
This technique enables you to deal with these expenses effortlessly and hopefully in the future, you won't think twice about an extra large outlay in any particular month.
Fund your Freedom
What you need is a Freedom Fund and it's no more complicated than just another bank account. I used to have a bills account but in all honesty, I don't have a need for it now since I know (roughly) what goes out of my main account each month. It's those payments that are irregular which hurt me, usually more than I expect.
All you need to do is stash away a certain amount of money each month so that when those irregular payments come in, you already have the money to pay them. Immediate access to enough dosh to get them paid and not worry about it. No searching for extra money in any of your other accounts, no shifting money around to make it happen, just immediate knowledge that you're already covered.
Worrying stops. Mental freedom starts here.
How Much is Enough?
Only you can tell. You have a good idea of what comes in every so often so you need to decide how much to move aside. It's worth over-estimating so that if your car needs extra repairs this year, your Freedom Fund covers it. I suspect you should roughly tot up the totals you expect to come in over the whole year, divide by 12 months and maybe add 20-25%.
For example, and these are very rough figures (off the top of my head), I have:
- car registration - 1/yr @ ~$200
- car insurance - 1/yr @ ~$350
- car Warrant of Fitness - 2/yr @ ~$50 (not including repairs)
- council rates - 4/yr @ ~$350
- on-line subscription fees (Flickr etc) - 1/yr @ ~$40
- ... and others
So my initial stab at the cherry says I'll be taking out about $250 per month to cover all of these irregular items (I'm sure I've missed some off the list though) and give me a bit of leeway into the bargain. Of course, after a short while, you should review where you're at and see how much you are under or over the amount you expected.
Again, the best way to build this up is exactly the same as for your Emergency Fund and yank this money straight out of your account on the day you get paid.
What about my Emergency Fund, isn't that for stuff like this?
Yes and No.
Generally you don't want to touch your Emergency Fund but every now and again it makes sense. You noticed in my list above that I ignored the fact that I might have to make repairs to my car after it had been for inspection. In that case, it would be considered an expense that I wasn't expecting ... whereas all of the other things I've mentioned are expenses that are expected but just happen to be irregular.
In general then, leave your Emergency Fund alone and just plan that little bit ahead with your new and fresh Freedom Fund. Dip into it if you have to but at least think twice about doing it.
The Leftover Stash
Once you've been putting into your Freedom Fund for a while, you'll be able to determine if your original monthly amount was about right. If you're lucky that you have been doing double-entry accounting for years then you already have good figures to base this fund on. The rest of us however, will have to guestimate what we expect and re-adjust when necessary.
If you're really lucky, you overestimated and your Freedom Fund is now growing a surplus. If I were you, I wouldn't be too worried - just keep topping it up each month - after all, it's in a high interest savings account. Isn't it?
What are your thoughts on a Freedom Fund?
8 comments:
I think this fund is the main way to stay away from debt. Because everybody adds up their bills, subtracts it from their income, then says, well, I make enough money, what's the problem?
The problem is, you forgot you have to get plates for the car, you forgot that you need an oil change and new spark plug wires, you forgot the registration fee for the kids school is due in January, you forgot the water bill is quarterly, not monthly, yada yada yada.
I set this up in a spreadsheet, a column for each category and two rows for each month, credit total and debit total. When we buy a case of oil, I use the checking debit card, then transfer the amount from the IEF--Irregular Expense Fund. I attach a comment in the debit cell when we use the account, to track it, and the total tells me if I'm balanced with the bank. I had to add a column for interest, which was pretty fun.
And you find out when you're underfunded pretty quick this way. You can always make adjustments--e.g., animal medical expenses should be funded at the same rate the people are in our house.
@melanie:
Heh, you're so right. Thanks for your list of irregular payments. Whilst I don't have kids, I do have a cat so I should sock away a little more just in case she needs treatment. I knew there would be more I'd forgotten.
I see you use a spreadsheet for your IEF. I know it's not everyone's cup of tea but have you ever thought about using a double-entry accounting package? I've found it invaluable to track exactly what's going on (though I also see the idea of a simple spreadsheet to be quite nice too). It might be worth giving it a go sometime to see if you like it.
Thanks for the comment.
P.S. I still like my name for the account better than yours :-p
Hey Andrew,
A somewhat unrelated question that I would love to hear your thoughts on:
Mortgage repayments vs. Kiwisaver.
My wife and I both earn decent incomes. Currently we rent, but we are about to buy a home in the next 6 months. Our wish is to repay our mortgage as soon as possible (preferably within 10 years).
We currently put $20 a week each into kiwisaver to get the maximum returns from the Govt. This costs us $1040 each a year (so $2080 together). It returns (in the current permutation) $1040 from the Govt each year (roughly), which is very nice for our retirement - but we're both in our early 20's.
So, the question is, do we continue to fund our kiwisaver to the combined tune of $2080 a year, or should we go on a contributions holiday and instead redirect that towards our mortgage. Almost certainly mortgage repayment is smarter in both the short and long terms, but I'd love to get your opinion.
Cheers,
Jonathan
@Jonathan:
Thanks for your question. I'm really not a financial expert so you should do one of three things:
1) do your sums :-)
2) read lots and lots about personal finance, blogs, books, get as much information as you can
3) seek professional advice
I know that sounds like a cop-out but you know your finances more than anyone else therefore it'd be hard for me to give advice.
I can tell you what I'm doing though.
Currently I'm saving 4% in KiwiSaver. I'm also setting aside money in an Emergency Fund, just in case. Finally, anything extra I have that month goes against my mortgage. I want that paid off by the time I'm 40 (which will be 10 years and 2 weeks).
Of course I'll be reviewing all of these things over time to see where I am at each stage.
By the way, can I use your comment as the basis of a future post? I think there are some interesting points to note from it.
Hello,
Sure, use the comment for a future post if you like. If you feel particularly generous my website can be linked to at http://www.JoGiles.co.nz.
I still wonder, even with your response, isn't the best thing to do repay the mortgage (in your circumstance as well as my future one)? Of course you miss out on the Govt contribution in the short term, but you're potentially repaying a nice chunk of your mortgage off if you go on a contribution holiday. Repaying a mortgage at ~9% interest (especially in the early years where the size of the loan is considerable) is likely to earn more money than a kiwisaver contribution would (even taking into account the Govt sweetners).
-- Jonathan
In some circumstances, yes, paying off your mortgage is a good thing to do.
But you have to consider eggs and baskets. If you just concentrate on your house, then you're putting all your eggs into the NZ housing market. What about stock and shares? What about property abroad? Granted, it gives you a roof over your head but that's not the only consideration.
The way I see it is, you're planning on paying it off in 10 years. Even if you pay it off within 15 years, you're in a much better position than people who leave it going the whole 25 or 30 year repayment.
One thing I'd say is, with your $20 contribution to KiwiSaver per week, you're getting $20 off the Government. Even when you have a house, can you afford $20 a week? I'd say keep at it since you're doubling your money immediately. That's not to be sniffed at. How many other ways can you double your money. Especially so since you're still young with no dependents. All the interest on that money over the next 32 years will be enormous.
Get yourself onto Sorted and see how it all turns out. Compare and contrast different strategies.
Thanks for the response. I have spent a fair bit of time 'playing' on Sorted, and my main take away message was the enormity of even a minor increase in mortgage repayments. I like this as I am loath to have a mortgage for any longer than necessary. At the moment all my money sits in the bank earning ~8% interest. Soon that will be flipped around and I'll be owing the bank ~9% interest on a, roughly, 250k mortgage.
For me, shares and overseas properties etc are not a primary concern. Perhaps they should be, but to me it seems prudent to focus on the most major debt first, which of course is the mortgage. I don't know where I heard it, but I tend to look at servicing debt as the best way to save in the long term. For that reason I see no sense in putting money into shares or retirement (now), but once the mortgage is paid off (when I'm roughly 35-38), I can start looking into these things.
Perhaps short sited, perhaps wise....I don't know.
-- Jonathan
Jonathon,
I like your plan but I don't think you should underestimate the importance of having a good pension plan sorted from as young an age as possible.
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