Savings and Emergency funds for ER

[free4now]

Budgeting skills seen more important when ER than when working and saving for ER. At least in my case where I'm looking to ER on less income than I took when working. I'm trying to get together a plan for making sure I don't exceed my SWR in ER.

The most difficult part to figure out is dealing with "lumpy" expenses like replacing the car, replacing the furnace, dealing with unexpected health expenses, even replacing a computer. It seems that these can be lumped into two major categories, those that are relatively predictable and those that aren't predictable.

While working and saving for retirement I generally didn't do a whole lot of budgeting around these things... I spent a monthly average well below my means and then handled big lumpy expenses out of savings where necessary. The downside to this approach was that I never have a very clear idea of exactly how much I was spending per year on what.

It seems like the most conservative thing to do would be to handle lumpy expenses in the same way my condo association does: make up a list of all items that will need replacing or work done in the future, assign dates and costs, leave some extra for the expected unexpecteds, and then figure out the monthly payment that will fund a reserve fund such that it doesn't go below zero in the worst month.

I would probably want to keep two "funds" both of which are funded by regular monthly transfers out of the income pile:

1. Emergency fund for truly unpredictable things like health or car costs.
2. Savings fund for more predictable replacements of consumer goods.

The reason for having two separate accounts is that if there were only one account I think I might be tempted to spend the "emergency" portion on predictable expenses.

Whether to have actual accounts or just a spreadsheet is one decision point, and the other decision point is just how to determine the amount to fund these accounts.

As far as determining the monthly amounts to fund these accounts, that seems to be a process of looking at what past expenses have been and also looking forward to future known expenses. Perhaps once a year I should sit down and review the balances and funding of the accounts.

I'm very curious to hear how other people handle lumpy expenses in ER.

Do you use separate account(s)?
Do you distinguish between predictable and non predictable expenses?
How do you fund these accounts?
Do you have set rules for what categories of items come out of them?
What do you do if you have an expense greater than the amount in the account?

[LOL!]

I disagree with the premise that budgeting in/out of ER is different.
We don't have separate accounts nowadays for different things.

Our emergency fund and short-term reserves are held at ING or in a money market. All of those fulfill the asset allocation class "short-term reserves". We fund these accounts the same way other accounts are funded: with money from our paychecks. I imagine in retirement we would fund them with dividends.

If I had an expense greater than in the account, I would probably be dead.

[free4now]

You're probably right that budgeting works similarly in and out of ER... the reason I have to improve my budgeting is because I'm going to live on less in ER.

But I do think that a budget is more important in ER; when you are working going over budget means you delay retirement, but when you are ER exceeding SWR risks death spiralling into losing everything.

[alphabet soup]

fireme, I will have been ER'd ten years this coming August. All distributions from a 50/50 allocated portfolio goes into a money market sweep account.

A budgeted amount from there goes quarterly into a bank checking account. This covers fixed expenses as well as misc. expenses based on last year's actual figures.

A fixed amount of $30,000 remains in the sweep account for large, unexpected needs. As you mentioned, car replacement, new roof, furnace, what have you.

At year end, any amount in excess of $30,000 is reinvested to income producing funds, mostly tax exempt. The new year begins with the same base amount of $30,000 as a year earlier.

The sweep account is held as a cash reserve and not included as part of the investment portfolio.

This works for me.

[free4now]

Thanks alphabet soup for sharing your approach. The simplicity is certainly appealing. Have you ever had a year when the $30k wasn't enough for all your lumpy expenses? And do you have any rules for what comes out of that $30k account and what doesn't, or do you just use your judgement?

[alphabet soup]

Originally Posted by fireme

Thanks alphabet soup for sharing your approach.* The simplicity is certainly appealing.* Have you ever had a year when the $30k wasn't enough for all your lumpy expenses?* And do you have any rules for what comes out of that $30k account and what doesn't, or do you just use your judgement?

So far, the only time I've had to go to the well, so to speak, was winter 2003 when outside water pipes from the well to the house froze and had to be replaced. Cost over $11,000. My rule of thumb is any single expense, up to $1,500 or so, comes out of operating capital which is budgeted for. Unexpected expenses, in excess of that amount, comes from the $30,000 reserve.

Started Jan. 1, 2005 with $30,000. On Dec. 31, the balance was $51,000. The excess was reinvested in tax-free bond funds.

We'll see how 2006 goes.

[cute fuzzy bunny]

I have too much set aside and am changing that. Granted we have a regular monthly income from my wifes residual salary, and some cd and bond interest thats direct deposited. I'm probably going to continue to reduce our cash position, keep $5k in the checking, another 10k for "Aiyeee! money" and go to the HELOC if anything bigger than that happens. Probably keep the rest in something liquid, involatile, but good returning like Target Retirement Income or Wellesley. Hard to take a 4.something yield from a mutual fund when you can get 4% from a money market though.

[arrete]

Hi!* I'm baaack.* Budgeting is how I got to ER and I still do it.* I keep a pretty detailed budget, just to see where a problem area might be.* My car cost more than I expected last year (not just gas), so this year my estimate is a bit higher.*

I don't have a savings or emergency fund per se, but I do set aside a certain amount in the budget for "just in case".* If it's a good year, I get to spend some of it on fun stuff (yay!).* Bad years, I just have to take more out of my money market fund.* I've never been above 4%.* Until this year - major kitchen redo.* I'm considering that differently because I've saved specifically for that and to include it in my withdrawal rate would be misleading.* The remodeling will cost more than I usually spend in a year.* But next year I'll be good again.

If I had a major expense that was more than I had in my MMF, I would either 1) sell some stock or if things were dire, use margin as a loan.* I've never gone onto margin, but it's nice to know it's there.* It would have to be a really awful expense like over 100K.

I also keep lots of slack in my budget for "just in case".* That's why when something bad happens (car) my budget still comes out OK.

It's hard to keep up with you guys because you post so much.

arrete

[free4now]

As far as the fixed day to day expenses, I'm thinking once a year I'll sell equities worth a bit more than 3% of net worth, drop that money into an ING savings account, and then every month do a transfer of 1/12th into my checking account.

Because I'm not sure I'm permanently retired and find it likely that I'll go back to part time work at some point, I'm going to stay 100% invested in equities, not making a 5 year bond ladder or any such cushioning vehicle. That way if I go back to living off work income I won't be saddled with the unnecessarily low return rates of that bond ladder. I know this is a bit riskier than incorporating a bond ladder and so I am prepared to reduce withdrawls in a downturn to compensate for the increased risk.

I'm leaning towards doing the lumpy expense accounting using a spreadsheet to keep track and writing checks from the brokerage margin account for the actual money. The margin loans will get paid off by selling equities at appropriate times.

[Nords]

Originally Posted by arrete

Until this year - major kitchen redo.

Pictures, please!

[Martha]

Originally Posted by arrete

Hi! I'm baaack.

Until this year - major kitchen redo. I'm considering that differently because I've saved specifically for that and to include it in my withdrawal rate would be misleading. The remodeling will cost more than I usually spend in a year. But next year I'll be good again.

arrete

We saw the before pictures and can't wait to see the after. Are you taking any of the suggestions posted or did you blow us all off?

[arrete]

Yes I took suggestions on the remodeling.* The discussion actually helped a lot.* It's not happening until September.* That's how booked these people are.* We're going with Corian (I'm scared of marble - besides, you can sand Corian if you make a booboo), custom made cabinents from Honeybrook, top of the line Armstrong flooring (haven't picked that yet) and, yes, the tin ceiling.

For those who haven't seen the before, here it is
http://early-retirement.org/forums/i...p?topic=2189.0

Sorry to hijack the thread - now back to emergency funds.

arrete - I'll ask some questions on Other Topics

[free4now]

The kitchen remodel is an interesting expense from an accounting perspective. Part of the cost can be considered an investment which will increase the value of your home, and therefore I would say shouldn't be all considered a "withdrawl". It does take that money out of your investments though and moves it into home equity where it won't be compounding.


But some portion (I think about 25% in the case of kitchen remodels) is a withdrawl because it won't be recovered on selling. I think I would account for that 25% or so as spending. Actually maybe I'd increase the amount to 40% or so to cover the loss of compounding from the whole expenditure.

[arrete]

The kitchen remodel is an interesting expense from an accounting perspective. Part of the cost can be considered an investment which will increase the value of your home

Alas, we have a small home on a double lot 10 miles from DC. It would be sold for the land alone. The house would be torn down, and 2 McMansions would be built.

We told the designer that we weren't going to consider resale at all in our decisions. Sometimes you just have to accept reality, even if it's that your home will be torn down.

arrete

[free4now]

Ouch, well it's good that you can see that clearly.

Kind of reminds me of the Burning Man festival where people build these elaborate structures in the middle of the desert and then everything gets dismantled and largely trashed a week later. I'm assuming you'll be staying in your home a lot longer than a week though.

[Nords]

Originally Posted by fireme

But some portion (I think about 25% in the case of kitchen remodels) is a withdrawl because it won't be recovered on selling.* I think I would account for that 25% or so as spending.* Actually maybe I'd increase the amount to 40% or so to cover the loss of compounding from the whole expenditure.

I think if you peruse Arrete's photos you'll agree that it's time to make the investment, and that they'll recover at least 100% of it on resale.

Not that resale is the purpose of the home improvement!

[kz]

I've tried to simplify our savings/emergency funds in ER.

I keep $4,000-5,000 in a simple savings account for small expenses. (water heater, car repairs, home maintenance, etc.)

I keep $15,000-25,000 in a money market account for larger expenses. (car replacement, landscaping projects, home remodeling, etc)

Since we don't need to dip into our IRAs or 457 accts those are earmarked for medical emergencies not covered by our medical insurance.