Do you keep a reserve fund?

[tightasadrum]

Rich,

This is a timely subject for me. Right now I just have a big chunk in VG & Fido
MMF's while I try to figure it out. But I want to move a lot of it into ETF's and MF over the next few months. This thread has some good ideas. I particularly like the idea of annually or monthly accruing into a fund to be used for special big items. Somehow that would just feel better when it is time to write the check.Maybe I could go ahead and fund the big ticket account for the known big ticket expenses, and then just add an inflation factor each year until it gets a hit. After that, I could increase the funding, looking forward at expected life, and add that amount. At some point I could stop funding it due to simple life expectancy. We all gotta go sometime.

 

[Moemg]

I don't separate it either physically or accounting-wise. I do keep a minimum of about $35,000 cash in a taxable account. Also, since I practice cash flow investing, I have a lot of dividends and interest landing in the account every month, so that $35,000 which is close to a year's living expenses should see me through most things.


Ha

I do the same but I also take whatever money is left over at the end of the year from my 4% and add it to the fund.

 

[TargaDave]

We have a very large cash position (currently earning 7%) - 45% of our portfolio is cash - so we don't have to worry about unexpected large purchases.

Similar approach for us but we don't earn close to 7%.

 

[KB]

I also have a good sized reserve fund. However, mine is sort of the bucket system too.

Bucket 1 is basic expenses amount for 2008.
Bucket 2 is roughly 4 year's expenses; mostly cash and some mutual funds.
Bucket 3 is retirement accounts. Won't touch until the appropriate age.

Any large (new roof or car sized) or unexpected expenses would be paid from Bucket 2. Bucket 1 has enough for all planned and known expenses for the current year including some slush.

 

[shoe]

I do something similar to retire@40. I have separate funds for car replacement,car repair, home repairs, and one for appliances. I fund the car replacement and repairs with money DH is reimbursed for mileage; roughly $350 a month. Home repairs (a new roof this year) comes from his second career paycheck and the appliance account is funded with rolled coin, rebates, and ebay money. It is so interesting to see the different ways others handle this.

 

[lazygood4nothinbum]

when the roof and tires go i'm selling what's left of the house & what's left of the car and vagabonding for the rest of my life. problem solved.

 

[walkinwood]

I plan to use an Asset Allocation strategy that has 4% cash which I will keep in a MMF. Dividends from the taxable account will also flow there.I'll work through that cash through the year. At the end of the year, I'll rebalance the entire portfolio to give me 4% cash for the next year.

If I need more cash for an emergency, I'll sell the best performing asset for the year to raise it. If equities are showing a loss, I'll sell ST bonds.

Probably needs some more tweaks, but I figure I have the rest of my life to work on that.

This modeled on my understanding of what Bob Clyatt says in his book.

 

[DangerMouse]

Let me ask the obvious. How are you earning 7% in cash?

We have money interested in Australia, our homeland. We are actually earning 7.25% on a term deposit which is the same as a CD. However it is possible to do better than that. Can get 7.70% at Rabobank for a 180 day deposit. Money we have in the UK is earning 5%. Worst rate of return for cash is in the US. However, on the other hand mortgage interest rates are a lot higher at these locations. It's possible to get 6%+ for monies that are deposited at call in Australia.

However I wouldn't recommend anyone transferring funds to Australia at the moment as with the US$ in the toilet you will be taking a total bath on the exchange rate.

 

[DangerMouse]

Actually I just double checked and you can get 8.05% at Raboplus.

 

[SteveR]

I have about 10% cash right now. It is split up into 5 different accounts (long story). We use the main credit union MM account for your "daily" expenses and if we run out we go to our Vanguard MM account. If that runs out we have another brokerage account with several CDs and index funds.

When we sold the cabin last year we took the profits and used them to upgrade the house kitchen, put a big down payment on a RV, did some custom upgrades to the house and the rest went into the MM or CDs.

We don't have a "bucket" with the name "Emergency Fund" on it. If I need the cash I do a wire transfer into my checking account and then write a check. The "need" is planned but I choose not to have individual accounts for only narrowly focused items.

 

[Ronstar]

I have a cd, 2 savings accounts and an interest bearing checking account for emergency savings. I'm in the process of converting most of this cash to index funds. I'll probably leave 1 year of expenses in these cash accounts.

 

[Eagle43]

I've got about 10% in VG Prime MM. Further, I've got a lot of old bonds which I consider good as cash. Should a real emergency show up, I should have it covered.

 

[freebird5825]

i keep my spending down so i have savings, and i keep a money market emergency fund in the wings for instant cash. i also have a nice fat tax free muni bond fund (VWAHX) earning steady dividends, from which i have immediate check writing privileges. i plan to use this as an OMG big ticket item reserve. since the fund NAV doesn't change much, my capital gains hit if (when) i sell shares is minimal. in some cases, a loss.

if i were to sell my long term stock funds, i would not only take a captial gains hit but also miss out on any future growth. these are an absolute last resort for me.

i'm less than a year into the FIRE act, so the validity of my strategy is TBD. and my age is a huge factor in my approach, i.e. 49 and holding.

any comments from the expert FIRE folks?

 

[jIMOh]

I accrue these expenses in my annual budget.

For example, if you estimate you will buy a car costing $30,000 every 10 years, then you would accrue $250 monthly ($30,000 / 120 months) just for that purchase.

I do this with all expected future purchases that have an effective life of more than one year such as the roof, boilers, washers and dryers, TVs, furniture, etc. I also accrue anticipated medical expenses such as future root canals and implants, and out of pocket medical.

This should be part of any budget for purposes of determining a SWR.

This approach makes the most sense to me. Having the funds in a taxable account- of a conservative nature (not 100% money market, but maybe 80% cash and 20% something else).

I think the issues here are
1) knowing the expenses and budgeting for them
2) starting this fund prior to retirement (so the well is not dry if everything craps out the day after FIRE)
3) the frequency of the expenses. 1 car every 10 years makes sense. What if that second car only lasts 5 years?
4) the inflation of the expenses. Maybe big ticket things have a different inflation than consumer goods.
5) accounting for as many less than annual expenses within spending (withdraw rate) as possible.

 

[retire@40]

I think the issues here are
1) knowing the expenses and budgeting for them
2) starting this fund prior to retirement (so the well is not dry if everything craps out the day after FIRE)
3) the frequency of the expenses. 1 car every 10 years makes sense. What if that second car only lasts 5 years?
4) the inflation of the expenses. Maybe big ticket things have a different inflation than consumer goods.
5) accounting for as many less than annual expenses within spending (withdraw rate) as possible.

This is one big guessing game, but it's better than not guessing.

True, you can budget for a car lasting 10 years based on past experience and it could turn out that it dies in 5. Well, it could die in 2 years, it could die in 12 years, but you have to take a guess based on something.

Inflation is a key personal number. Again, you have to project forward based on a set of assumptions.

You can always put a "miscellaneous" line items for a fudge factor if you think there may be something else that could come up not accounted for.

 

[youbet]

However I wouldn't recommend anyone transferring funds to Australia at the moment as with the US$ in the toilet you will be taking a total bath on the exchange rate.

I'm certainly no expert on exchange rates (to say the least!), but even if the current exchange rate is unfavorable, as long as it held steady while I had funds in an Australian interest bearing vehicle, I would suffer no penalty when I exchanged back. Right? It's the relative exchange rate varying over time that causes exchange rate risk, no?

 

[youbet]

I have about 10% cash right now.

I think that is the critical metric. The percentage of cash/near cash you hold in your overall net worth to meet your planned and unplanned liquidity requirements is what matters. Putting special names on accounts might help you keep your head straight as to what you're doing, but doesn't change the liquid assets available. Nor does it change the opportunity cost you're paying for holding liquid assets.

We don't have a "bucket" with the name "Emergency Fund" on it. If I need the cash I do a wire transfer into my checking account and then write a check. The "need" is planned but I choose not to have individual accounts for only narrowly focused items.

Yep. That's what works for me. I do admit, however, that back in the bad ole days when I was w**king, I did do some things with focused, segregated accounts. For example, after buying our first new car on time payments (1970 VW Superbeetle), I started a payroll deduction into a credit union account at work so I could buy the next one for cash. For some reason, I needed the clarity and security of seeing those bux accumulating unadulterated by other cash on hand. Of course, it was all in my head. If I had needed those new car account dollars for some emergency, I would have grabbed them without hesitation.......

 

[jIMOh]

This is one big guessing game, but it's better than not guessing.

True, you can budget for a car lasting 10 years based on past experience and it could turn out that it dies in 5. Well, it could die in 2 years, it could die in 12 years, but you have to take a guess based on something.

Inflation is a key personal number. Again, you have to project forward based on a set of assumptions.

You can always put a "miscellaneous" line items for a fudge factor if you think there may be something else that could come up not accounted for.

I hope my post was not interpreted as questioning how you do things. If anything your post made the most sense, and I posed the questions as much to myself as I did to the whole board (is that a "rhetorical post"?).

My thought was this-

If many of those expenses are long term (roof, car, house repairs) and accounted for in withdraw rate, there are two slush funds

1) the slush factor built into expenses and the starting withdraw rate.
2) the slush factor on earning interest before the expenses accrue.

2) is more of the buckets thing. My thought was there are two buckets- the money accounted for for SWR and the money withdrawn but not spent yet.

Your choices for the latter are to not withdraw the money at all (you will pay taxes on the withdraw), or withdraw it, pay taxes, then set it aside. My thought was to withdraw it and set it aside. Put 50% into cash (earning an average of 3%), and put 50% into a moderate mutual fund (PRPFX is my personal choice- earning around 6%). In 12 years time the second portion of that doubled, minimizing need to continue including in withdraw rate.

 

[retire@40]

I hope my post was not interpreted as questioning how you do things.

Not at all. I was just elaborating.

 

[Kronk]

At what point are tax-exempt MMF's or Bond Funds worth it?

Is it as simple as comparing the ratio of returns to your marginal tax rate?
So if Taxable Fund A returned around 4% and Tax-Exempt Fund B earned 3%, then B/A = 25%. If your tax rate is over 25%, go with Tax-Exempt?

Is the answer the same for both bonds and money markets?

 

[TickTock]

We keep about 6 months of current expenses in a MM fund. Since DW and I both work for separate companies and the chances of us both getting laid off together are slim, this would be over a year's worth of one income earner for us.

If we anticipate a large expense, we start building up the MM.

Having walk-away money can be very comforting.

 

[jIMOh]

At what point are tax-exempt MMF's or Bond Funds worth it?

Is it as simple as comparing the ratio of returns to your marginal tax rate?
So if Taxable Fund A returned around 4% and Tax-Exempt Fund B earned 3%, then B/A = 25%. If your tax rate is over 25%, go with Tax-Exempt?

Is the answer the same for both bonds and money markets?

For taxable accounts/taxable interest, the calculation is

(1-tax bracket)*interest rate=real rate

so if in 25% bracket, the real rate is 3/4 what you really get. (1-.25)*interest rate.

If tax free MMA was 2.5% and taxable MMA account was 3.5%, the math looks like this:

(1-.25)*3.5%=2.65%
which is greater than 2.5% tax free, so stick with taxable MMA.

The tax free accounts really kick in for 33 and 35% rates, is my experience. Same example above in 33% tax rate:

(1.-33)*3.5=2.34% which is less than 2.5% tax free, so the tax free MMA is a better deal.


The 3.5% and 2.5% rates I used are pulled out of thin air- no idea what the APRs are on those accounts right now (I am in 15% or 25% bracket and I use CDs for my savings).

 

[Nords]

Nords: Let me guess. You quit buying a $10.00 Pizza at Costco on Fridays.

Well, hey, some necessities you just have to draw the line on and include in your core budget-- no matter how bad things get!

But I have cut back on the ice cream...

 

[free4now]

I just take large purchases out of the MM account that has about a year's worth of expenses, just like I pay for small expenses. The MM account gets replenished with whatever my estimate is for spending over the next year, which includes anticipated large purchases. But I'm not at all exact on the MM account balance... if I'm off by $10k no problem just cash out more bond funds next time.

The way I look at it, it's useful to segregate the large expenses for budgeting purposes, including say $200/mo for car replacement on the budget. But for spending and investing there's no advantage I can see to segregating. The only exception might be if a very large purchase were to significantly distort your asset allocation.

 

[DangerMouse]

I'm certainly no expert on exchange rates (to say the least!), but even if the current exchange rate is unfavorable, as long as it held steady while I had funds in an Australian interest bearing vehicle, I would suffer no penalty when I exchanged back. Right? It's the relative exchange rate varying over time that causes exchange rate risk, no?

Well the greatest problem is who knows which way the exchange rates will go. For us it is not such an issue, as money we transfer to Australia we intend to leave there. Of course if we decided to pull all our cash out of Oz and moved it to the US now I am sure that we can do well on the exchange rate, but if we were to have to move it back we would be screwed unless the timing was right.