Do you keep a reserve fund?

[Rich_by_the_Bay]

I'm curious about how y'all handle the inevitable big expenses like car replacements, new roof, whatever - the big (> $5k) items that tend to be unpredictably predictable - you know it's just a matter of time. (I'm aiming this at the already-FIREd crowd.)

I know it's kind of a pointless excercise in the end since it all comes out of the same stash, but from a practical standpoint how do you manage these outlays? Do you just take it out of whatever investment seems fattest at the time? Do you plan ahead for it by keeping a reserve fund on the side (out of your main nest egg for SWR purposes)? How much do you carve out, for those who do so?

 

[haha]

I'm curious about how y'all handle the inevitable big expenses like car replacements, new roof, whatever - the big (> $5k) items that tend to be unpredictably predictable - you know it's just a matter of time. (I'm aiming this at the already-FIREd crowd.)

I know it's kind of a pointless excercise in the end since it all comes out of the same stash, but from a practical standpoint how do you manage these outlays? Do you just take it out of whatever investment seems fattest at the time? Do you plan ahead for it by keeping a reserve fund on the side (out of your main nest egg for SWR purposes)? How much do you carve out, for those who do so?

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.

If I tried to do buckets or something similar I would just get confused and give up.

Ha

 

[W2R]

I am not retired yet, but my plans are fairly similar to what Ha is doing in some respects. I plan to keep my Vanguard Prime Money Market VMMXX account, into which proceeds from my investments will flow, and out of which I will take my living expenses. This money market account will be big enough to handle reserves needed for the next car, roof, appliances, hot water heater, and so on. So, these reserve funds will be in money market, rather than funds, to ensure a nice, ready, painless liquidity. As far as SWR goes, I am expecting that I will not need a full 4% SWR anyway, or even 3%. So the reserve fund won't crimp my style by affecting my SWR. I will probably go ahead and include it when computing SWR just to simplify things.

As I begin ER in 2009, I plan to use a modification of my present Excel worksheet to keep track of these long term reserves.

Should interest rates on my Vanguard account fall drastically, I will have to re-think the emergency reserve arrangements.

 

[Gotadimple]

I plan to keep my Vanguard Prime Money Market VMMXX account, into which proceeds from my investments will flow, and out of which I will take my living expenses. This money market account will be big enough to handle reserves needed for the next car, roof, appliances, hot water heater, and so on. So, these reserve funds will be in money market, rather than funds, to ensure a nice, ready, painless liquidity. As far as SWR goes, I am expecting that I will not need a full 4% SWR anyway, or even 3%. So the reserve fund won't crimp my style by affecting my SWR. I will probably go ahead and include it when computing SWR just to simplify things.
quote]

Good topic, Rich. I have been puzzling over this for the last few weeks, as I get ready to retire in a few months. Just as W2R outlines, I was planning on using a money market account to hold my cash that I pull from the tax-deferred accounts for current living expenses. I am excluding the reserve from any investment allocation. It will just sit there in the MMF or in CD ladders, depending on the interest rate environment.

For those using this method, are the majority of your holdings in taxable or tax-deferred accounts?

I'm 80-20 (tax-deferred to taxable).

-- Rita

 

[FIREd]

I am not yet retired, but I already apply the following and will continue when I retire. Each year for example I place $2400 (which are part of my annual budget) into a dedicated "big expenses" money market fund which allows me to get a new roof every 15 years, a new A/C unit every 10-15 years, a new water heater every 10 years and still leaves me enough for miscellaneous repairs along the way. In the same MMF, I also put money each year for car repairs, car replacement, gifts and vacations (all those big ticket expenses that you know will come up sooner or later). I track each pool of money within the MMF using a spreadsheet. Overall, I place about 25% of my annual budget in the MMF each year to pay for those big expenses down the road.

 

[retire@40]

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.

 

[Nords]

You can do a couple one-time lump-sum expenses in FIRECalc, but we just added the lump sums to a spreadsheet (one roof every 20 years, kitchen appliances every 10 years, new car every 5-10 years) and then took the average.

We've realized that we've overestimated some expenses because I can repair a roof, Craigslist makes it a lot cheaper to buy appliances, and our cars are currently 10 & 14 years old.

We've also underspent in a couple of the last several years and we've just carried over the amount for the car we knew we would be buying in a year or two.

A few years of 10-15% investment returns helped fill in a lot of cracks, too.

 

[Twinkle Toes]

Currently about 85% pre-tax here, and we keep about 2+ years of living expenses in liquid accounts which also covers unplanned expenses. Our living expense accounts are included in our "nest egg" for SWR purposes, but I don't include real estate (sentimental ties to the family farm...always put it off balance sheet).

 

[CyclingInvestor]

I am 49, and have been retired about 16 months. I am living mainly on 72t distributions (generated
by dividends in my IRA), which are transferred to my taxable account each year. My taxable
account holds a bunch of stock, and a variable amount of cash - the $31k in it now is typical.
Whenever my checking account drops too low, I transfer $5k to it from this account. All
expenses, large and small, come out of this flow. I have never seen a need to budget further.

 

[Jarhead*]

We've also underspent in a couple of the last several years

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

 

[Tadpole]

I have 600 per pay period transferred to my car fund out of each pay check. Then, when I see a good CD rate, I put the money in the CD instead. So, right now, if I need a car it had better be a $10K used car because that is all the car savings that is not in the wrong place CDs. I need the cars to last two more years when some of the CDs mature.

 

[chinaco]

Over the years, I have kept a certain amount in a reserve fund for emergency (about 10k). No more than that because DW and I both worked and each one of our salaries could cover normal expense if one of us lost a job.

DW RE. I am planning to RE in the next several years. So I have been building a cash reserve fund. It is a bit large right now. I will be moving some of it to a short-term bond index fund to get a few extra basis points.

New money (except for my 401k) is going to fixed investments to help reach my target allocation (stock/bond) of 60/40 when we RE.


When we FIRE, we not hold a separate emergency fund. If we have an emergency, it will come from the general fund. If we have an extraordinary expense in a year, we will have lower average income to spend in the following 3-5 years. Our target RE income is an average over 3-5 year period. We will manage our expense that way rather than hit the exact mark every year. This will work fine for us since our RE target expenses are more than our current expenses while working.

 

[OAG]

Since I use purely a CD Ladder it is easy to have maturing CD's act as a potential emergency fund. If needed, redeem and use, otherwise just buy more long term (7 to 10 year CD's) for the last rung of the ladder. Has worked just fine for the past 30 years (sleeping is great). Helps to have those annuities (baiting) for day to day expenses (Military Retired Pay, SS and starting this year, RMD's).

 

[Rich_by_the_Bay]

I can see one advantage of keeping the reserve found out of the nest egg side: every time you spend $10K you "feel" like you are decreasing your income by $400 a year for the rest of your life. With a reserve, you swallow that nut all at once at the beginning and hopefully never miss it, as your SWR gets figured from what's left over.

All smoke and mirrors, but still kind of nice not to have to fret if you need a car when stocks are down, etc. I'm gonna have to do the same for health insurance premiums between FIRE and age 65, to the tune of $80 or $90K up front, I figure.

 

[WilliamG]

We do very similarly to haha. Cash is 2 1/2% in our overall allocation and is split between Vanguard Prime money markets in taxable and IRA. All dividends and interest flow to these accounts. We also have a 20% allocation to bonds which includes IBonds in taxable and a CD ladder in the IRA. If we have a major cash need (eg., new car) that is not covered by cash on hand or normal rebalancing we go to the bonds allocation for what is needed.

Rich, your comment about holding reserve "on the side" makes sense. We certainly did that for our new house purchase shortly after ER, but the above process has worked well since then.

Fyi ps - we have a sizable chunk in Wellesley so our overall non-equity allocation is greater than 22 1/2 %.

 

[Dawg52]

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

Basically the same thing here. Great minds thing a like?

 

[FinanceDude]

I keep a fairly large reserve fund, but don't manage it much at all. I'm not one to keep track of CD ladders or the like, I feel I don't need to scrounge around for an extra 1/2% on "reserve" funds.........

 

[youbet]

All smoke and mirrors, but still kind of nice not to have to fret if you need a car when stocks are down, etc.

Rich,

It is indeed smoke and mirrors Rich, but if it gives you perceived peace of mind to cover certain expenses from a separate account labeled "reserves," go for it!

It just doesn't work for me. If I'm accruing/spending for cars, roofs, hospitalization, etc., it doesn't matter to me what I label the dollars, when they're spent, they're spent.

In terms of not having to sell depressed stocks to cover expenses, that's a matter of liquidity planning and I do that. I just don't label my planned liquid assets as "reserves." For me, whether I write the check for the new car against a so-called "reserve" account or whether I write the check against my RE portfolio, it's all dollars and impacts my net worth exactly the same.

 

[DangerMouse]

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.

We used to have separate MM accounts for car, vacations etc. but I figured we were just kidding ourselves and creating work and making the situation much more complicated than it needed to be.

 

[ziggy29]

That sort of thing is just generally handled by my "emergency fund" in liquid savings vehicles (which doubles as the "save up for large purchases" fund). Right now we have about $30,000 there in two savings accounts, a money market fund and about $5000 worth of I-bonds (which I hope to never need since they are paying CPI + 3.4%). Eventually we'll build that up another $20,000 or so, so we can also tap it to buy our next car in a few years (and no more car loans).

 

[Dawg52]

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.

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

 

[Rustic23]

This may be more than you ask. We keep about four times our annual cash needs in a money market. I figure it keeps us from the ups and downs of the market and at the same time would serve as an emergency fund.

I also put in a sinking fund figure in my spread sheet to cover replacement of :roof, Wash/dryer, Sprinkler, Mower, Lawn Tools, A/C,Water Softener, Kitchen Apply, Dishwasher, Stove, Frig, Paint, Carpet, Furniture
That comes to $4,500 a year. So when I do my annual budgets this number is in there.

 

[audreyh1]

I keep a MM fund with 1 to 3 years in living expenses outside our retirement portfolio. This is kind of like a "bucket" that helps us ignore short term volatility in our longer term investments (i.e. the retirement portfolio),

but it ALSO means we always have cash on hand to cover vehicle purchases, major repairs, etc.

Only once did we do an additional draw on the retirement fund, and that was to help cover our motorhome purchase. We often laugh looking back at this "imprudent" step that supposedly reduced our potential annual income, because the retirement fund has increased well over 25% since that large withdrawal! Heck, it's almost as if buying the motorhome caused our retirement fund to go up big time! LOL!

I thought you were doing the bucket thing, Rich, so I don't see why bucket 1 shouldn't cover short term large ticket cash needs.

Audrey

 

[Rich_by_the_Bay]

I thought you were doing the bucket thing, Rich, so I don't see why bucket 1 shouldn't cover short term large ticket cash needs.

I'm sure it could, though I think it would be simpler to do what you're doing from the get-go (an extra bundle to the side, set it and forget it til needed).

The whole thing needn't get very complicated, but it is interesting how differently people address it.

 

[kaneohe]

combination of money market reserves, CD ladder, and just in case.......HELOC
which hopefully will never have to be use........but no cost to obtain or maintain
unless you use it.