How do you account for large infrequent expenses?

[JustCurious]

We often discuss annual expenses on this board which is a very important thing to track to determine if you are or can be financially independent. But when tracking your annual expenses, how do you account for large infrequent expenses, like buying a car or making major home repairs or renovations? For example, lets say your annual expenses for the last 3 years averaged 60k, but this year you decide to buy a new car for 30k so your total expenditures are 90k. Would you report your annual expenses for this year as 60k or 90k? Would you say your average expenses for the last 4 years was 60k or 67.5k?

I can imagine several ways of handling this. One way is to simply count all expenditures as expenses, regardless of how large or how infrequent. Another way would be to have a separate capital expenditure fund set aside for large expenses like a car or a major home repair or renovation, and track that spending separately. Is there a consensus on how to handle this?

 

[ERD50]

Consensus - hah!

What I've done (and it seems pretty common), is to put all upcoming large, infrequent expenses in a spreadsheet. Put in the year, and the amount, and how long it should be before repeating. Amortize each across those years.

Examples: new roof, painting the house, major appliances, cars, remodeling, etc.

Using car as an example, if you plan to replace every 10 years, and put $20K towards the new, that's an average $2K per year to reserve. I don't actually keep those funds in a reserve account, money is fungible, but it will work budget-wise over the long term.

I've found that if you spread them out a bit, they pretty much average out over the years. Sure, you might get hit with a bunch in one year, but on average that should work out. Tapping into the portfolio in any one year shouldn't be a big deal, as long as the averages work out fairly close.

-ERD50

 

[razztazz]

When I stopped working (1996) I made sure I had $40,000 bucks "offline" separate from my "Living Stash". That was a new car, a move to a different part of the country, and all sorts of emergencies that couldn't possibly happen all at once. Trying to infer or impute all these future expenses was way too vague to begin with, then there were several ways one could do it etc etc. A North Dakota Goat Rope. So I cut to the chase and just said: "Make sure you got a wad laying around." The $40,000 was based on a lifetime audit. In my entire life I hadn't spent that much money on ALL emergencies combined.

Over the years the $40,000 was just topped off and increased when I had the extra money.

 

[M Paquette]

That's what the Great Floating Slush Fund and Memorial Beer Party Revolving Account is for.

I went through 10 years of Quicken data to figure out roughly what our "unexpected" expenses looked like, tweaked it for stuff that I knew would be coming some day, like roof work and replacing cars, and multiplied by a fudge factor.

I then annualized that as a budget amount that I would set aside in a virtual account in my bookkeeping software. The account would accumulate my budgeted set-aside for surprise expenses, which I would deduct as spent.

I figured the annual set-aside in as part of my expenses that I would have to cover from my Safe Withdrawal Rate.

Now, I realize that the virtual account could go negative with a run of unfortunate events. On average, over time, though, with midcourse corrections it should behave like that Safe Withdrawal Rate does, in spite of the usual fluctuations. That is, it might go negative some years, but go unspent and accumulate in other years.


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[Sunset]

I also just consider my avg. normal yearly spending. Knowing that once in a while I'll have to shell out for something special.
Like the car I just bought
The key is to know long in advance where you are going to get this extra money from.
Its pretty hard to avg in the extras and is fairly meaningless unless you really are going to set aside that money into a fund each month. So I agree with razztazz and just have a pool of stash I can draw upon.

 

[clifp]

I significantly under budgeted for these things, so I put off doing them in 2008-2010 (De Nile ain't just a river in Egypt it is a powerful coping mechanism).
After running up great returns in 2009-2013, I declared a budget holiday and spent like a drunken sailor in 13/14.

ERD and Paquette approach is far more sensible.

 

[Balance]

I have incorporated all of the suggestions above. I calculated Capex expenses for the next 10 years assuming a 20% contingency then set aside a Capex fund that covers the maximum I might spend in any given year times 1.5, but I amortized the capex costs for the 10 year period to arrive at a line item for the annual budget. Why, amortize? Because I wanted to make sure I was covering my long term (Capex) expenses each year with my income. If I was not, then I might look to increase income with a part-time work or make an adjustment to my discretionary spending that year. All that said, it's a work in progress, but as long as I am running with a plan I can make adjustments. I think the fact that you understand the need to plan for these expenses and you are realistic about what they may be then you will be fine.

 

[Hermit]

That's what the Great Floating Slush Fund and Memorial Beer Party Revolving Account is for...

I have found that if you make that fund big enough when you start, it can handle most anything, including DS who has decided to make going to college a career on Dad's dime.

 

[MichaelB]

We fund large expenses separately from the budget. Some $$ were set aside when I first retired to pay for things we knew would happen, such as college, graduation gifts and weddings. Other large expenses, like a new car or roof, come from a separate budget set up for that purpose, which I contribute to when the portfolio has above average years.

 

[papadad111]

And in some cases you can economize those capital expenditures. If times are tight a 12K nice used car will probably suffice versus a 20k new car.

New roof...maybe less able to economize the total cost, but sometimes timing can be deferred for a year or two without major ill effect -

If you're like most here you are planning and conservative on your timing and cost assumptions.

You should definitely include large capex in total needs.

How you budget and actually spend for those can be based on convenience, what ever methodology you use and in some cases how the tax authority may recognize the capital expense.

 

[Ronstar]

I fund big home repairs from a separate capital account outside of my budget. I haven't purchased a car since I retired but the payments for my low interest car loan are in my budget. I may continue this as I buy cars in the future.


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[scrabbler1]

When I stopped working (1996) I made sure I had $40,000 bucks "offline" separate from my "Living Stash". That was a new car, a move to a different part of the country, and all sorts of emergencies that couldn't possibly happen all at once. Trying to infer or impute all these future expenses was way too vague to begin with, then there were several ways one could do it etc etc. A North Dakota Goat Rope. So I cut to the chase and just said: "Make sure you got a wad laying around." The $40,000 was based on a lifetime audit. In my entire life I hadn't spent that much money on ALL emergencies combined.

Over the years the $40,000 was just topped off and increased when I had the extra money.

I, too, have a separate account (worth $40k, like yours) like a slush/capital fund I use for very large expenses. It is in addition to my emergency fund although money is fungible so I kinda consider the two alike. It is in another muni bond fund so it is simply part of the bond portion of my overall portfolio.

 

[donheff]

I did what several others suggest. I budgeted in an estimate for large expenses (cars, roofs, etc) and I over budgeted for travel. That leads to an excess in many years which I annotate in my portfolio spreadsheet in a pseudo account for unusual expenses and splurges. Last year I had a couple of those expenses and I debited the pseudo account. I also track the actual amounts/percentages of holdings spent to see how things are trending.

 

[REWahoo]

One way is to simply count all expenditures as expenses, regardless of how large or how infrequent.

^ This.

Yes, it's lumpy and bumpy but it is what it is. To my way of thinking, it all comes out of the same "pot-folio" anyhow, so I see no need to do any special accounting.

YMMV...

 

[ls99]

++ on the same pot. Just grin and bear it, and pay up.

 

[Mo Money]

I had to look up "North Dakota Goat Rope."

Like many others, I thought through the likely future big payments (car, roof, large vacations, helping my aging parents, random emergencies) and budgeted for it. I keep it all in one segregated account. For some payments, I just set the money aside if they are likely to be one-time expenses - e.g., the roof. But for recurring expenses like vacations and a car, I amortize, adding monthly amounts from my budget, since I will need to replenish those amounts periodically.

I might add that I am envious of M Paquette's names for this type of fund. Mine is named Various and Sundry or something like that. I need to get a bit more creative; Memorial Beer Party Revolving Account is hard to beat....

 

[Midpack]

This subject has come up before, so apologies for repeating myself.

I also show all expenses in the year they occur, BUT we have all the large infrequent/unpredictable expenses budgeted under a category called "accruals." We track variances for each category in our budget, that could be somewhat meaningless if we did not have accrual categories.

Some examples we consider accrual items are car purchases (predictable) or HVAC/roof/appliance/furniture replacements. Since I have some idea how much and how often these expenses hit, I've built a spreadsheet projecting those expenses for the next 35 years (inflation adjusted), and I "budget" for the average from those projections each year. Yes, it's irregular most years but the average will hopefully be reasonably close. So our category variances are all meaningful, and we've budgeted for the unexpected to the best of my ability.

Our accrual average is (round numbers) $10K/yr, and all our other expenses (without healthcare) are about $45K/yr - IOW "accruals" are significant, and should be included in budgeting somehow.

My 2 cents...

 

[pb4uski]

I provide for cars and boats in our budget by including depreciation in my living expenses, so my portfolio implicitly has enough for occasional car and boat replacements. We built a new house just prior to retiring, so I don't include an specific provisions for major repairs, any major repairs are just implicitly covered off by the redundancy in the portfolio (portfolio is greater then 100% survival amount).

 

[David1961]

^ This.

Yes, it's lumpy and bumpy but it is what it is. To my way of thinking, it all comes out of the same "pot-folio" anyhow, so I see no need to do any special accounting.

YMMV...

This is the way I look at it, too. I want to keep track of what I spend when I spend it.
I keep a spreadsheet of my monthly expenses for several years back, so if I want to smooth it out, I can calculate my "10 year moving average" of spending, which includes many of those large infrequent expenses.

 

[jollystomper]

I keep a spreadsheet of my monthly expenses for several years back, so if I want to smooth it out, I can calculate my "10 year moving average" of spending, which includes many of those large infrequent expenses.

+1

I do this as well, through Quicken which I've used since the late 90s. I can get a moving average, as well as estimate the frequency when large expenses might occur, to plan for them as best as possible.

 

[Meadbh]

This is a very helpful thread. Thanks to everyone for their ideas.

To some extent I am smoothing the cost of major home repairs by living in a condo (with a well funded reserve), but there are many other potential big expenditures. I started ER with a big monthly car payment, which will soon come to an end. Perhaps I should set an equivalent amount of money aside somewhere safe for future "gotchas".

 

[Live And Learn]

This subject has come up before, so apologies for repeating myself.

I also show all expenses in the year they occur, BUT we have all the large infrequent/unpredictable expenses budgeted under a category called "accruals." We track variances for each category in our budget, that could be somewhat meaningless if we did not have accrual categories.

Some examples we consider accrual items are car purchases (predictable) or HVAC/roof/appliance/furniture replacements. Since I have some idea how much and how often these expenses hit, I've built a spreadsheet projecting those expenses for the next 35 years (inflation adjusted), and I "budget" for the average from those projections each year. Yes, it's irregular most years but the average will hopefully be reasonably close. So our category variances are all meaningful, and we've budgeted for the unexpected to the best of my ability.

Our accrual average is (round numbers) $10K/yr, and all our other expenses (without healthcare) are about $45K/yr - IOW "accruals" are significant, and should be included in budgeting somehow.

My 2 cents...

+1. My budgeted accruals are 8k / year. The 8k is used to calculate my budgeted WR. My actual spend includes whatever I do end up spending. So, for example, my actual spending on 'accrual items' was 23k last year so I was 15k over budget last year. I expect to be underbudget for several years to offset this so that, on average, my spend will be 8k.

In additional to this I have also excluded $56k from my portfolio in calculating my starting WR. The 56k is the "accumulated depreciation" left on all accrual type items (example, 2 year old 11k roof with useful life of 15 years has accumulated depreciation of $1767 = 11000/15 = 733 / year x 2 years = 1767).

 

[W2R]

We often discuss annual expenses on this board which is a very important thing to track to determine if you are or can be financially independent. But when tracking your annual expenses, how do you account for large infrequent expenses, like buying a car or making major home repairs or renovations? For example, lets say your annual expenses for the last 3 years averaged 60k, but this year you decide to buy a new car for 30k so your total expenditures are 90k. Would you report your annual expenses for this year as 60k or 90k? Would you say your average expenses for the last 4 years was 60k or 67.5k?

I can imagine several ways of handling this. One way is to simply count all expenditures as expenses, regardless of how large or how infrequent. Another way would be to have a separate capital expenditure fund set aside for large expenses like a car or a major home repair or renovation, and track that spending separately. Is there a consensus on how to handle this?

It's a lot easier to figure this out after retiring, because to me it was hard to know how to count retirement savings and preparations - - as expenses, or not? To me, paying off the mortgage and setting aside money to pay for a retirement car in cash were part of these preparations, the objective being to position myself so that I could go into retirement debt free. I had a hard time figuring out how to count these retirement preparations. Every spare cent was either added to my portfolio or used for these preparations. So, if they were counted then my spending would have been exactly equal to my salary. That didn't seem right either. What a quandary.

But now that I have retired, thankfully it's all pretty simple. Since retirement there have been a few major expenses: the water heater that broke, the dental implant, the new metal side door with keypad entry, hurricane repairs, and other major expenses. I choose to count all of these, to the penny, during the year in which the expense occurred.

^ This.

Yes, it's lumpy and bumpy but it is what it is. To my way of thinking, it all comes out of the same "pot-folio" anyhow, so I see no need to do any special accounting.

YMMV...

+1 This is my way of thinking about it, too.

 

[Walt34]

Like many we don't formally account for it but have access to a large lump of cash for the "stuff happens" category, like the replacement water line last November. I've never had that expense before and don't expect to again but it may happen.

Other stuff is a bit more readily foreseeable like a replacement car, furnace or roof but again I don't know exactly when those expenses will occur. But the funds are there to handle it. We don't really budget for it but we know that lumpy expenses will happen.

 

[razztazz]

Some comments above made me want to clarify a bit.

I --DO-- account for all these one-off big-time expenses. I just do not account for it in the normal monthly spreadsheets with my regular living expenses. It's like keeping two sets of books but in the "good sense".

At year's end I have Tally A: "Normal Ongoing Living Expenses which has a "Miscellaneous" category in it. That money comes from my regular money. (The 60/40 AA as it were) I don't see why my July expenses should show up as $15,000 higher than usual because I bought a car that month. Or $1200.00 higher than normal because I took a trip etc. That might lead to confusion later when I want to see just how much I NEED to get through the year.

Then there is the TALLY B: which would be the new car, new roof, big trip, sort of thing. That money comes out of my Offline stash so it doesn't upset the "math" of my normal SWR.

TALLY C: Is both together.

It's not like the big, unexpected expenses get paid for but are not booked anywhere.

I find this actually easier to do than lumping it all together but I understand others would see it as a needless complication. Left Brain vs Right Brain types...?