My wife has always maintained a sizable savings account, but having extra cash is new to me. Until recently, I had always lived paycheck-to-paycheck, often treading close to a zero dollar balance in my checkbook for months at a time. Now, though, I’ve not only established an emergency account, but set up a couple of targeted accounts as well. (One is for vacations, and the other is for a new car.)
My method works for me, but others have different approaches. In her book Debt-Proof Living, author Mary Hunt suggests a sort of “emergency fund plus“. Often when people struggle with money, she says, it’s not the predictable monthly bills that are the problem. People cannot cope with the unexpected things — not just emergencies (like a severe illness), but irregular expenses like auto maintenance, wedding and birthday gifts, or a new pair of shoes.
To deal with all of life’s surprises, Hunt recommends a Freedom Account. Here’s how it works:
- Determine your irregular, unexpected, and intermittent expenses. Because the past provides a good indication of the future, look at your records for the past year or two. Make a list of your expenses that don’t occur on a monthly basis. Divide them into broad categories and calculate our approximate monthly spending on each.
- Open a second checking account. Most of the tactics we discuss at Get Rich Slowly involve multiple savings accounts. Hunt advocates opening a second checking account to act as a Freedom Account. She further warns that “under no circumstances should you accept overdraft protection, ATM privileges, or a debit card for your Freedom Account”. This account is not for daily use.
- Authorize an automatic deposit. When you open your Freedom Account, instruct the bank to schedule an automatic deposit from an existing account based on the average monthly total of your irregular expenses. Pick a day of the month that works based on your cash flow. For me it’s best to have automatic transactions occur soon after I get paid.
- Start a logbook. “As far as the bank is concerned, you have a second checking account,” Hunt writes. “But you are going to treat your new Freedom Account as a collection of sub-accounts.” To do this, take the list of irregular expenses you created earlier and start a page for each category. For example, you might have pages for clothing, vacation, property taxes, and auto maintenance. Each month when the automatic deposit is made into your Freedom Account, you will divide that among the sub-accounts in your logbook. For example, if you transfer $200/month to your Freedom Account, you might manually add $25 to vacation, $25 to clothing, $100 to property taxes, and $50 to auto maintenance.
- Make a deposit every month. “This is going to feel weird in the beginning,” Hunt says. She’s right. It felt strange to me when I began to keep sub-accounts at my credit union, but now it’s second nature. I like having my money divided based on its intended use. With your Freedom Account, you’ll be transferring from your primary checking account to a secondary checking account on a specific date each month. Then you’ll further divide your money by hand in your logbook. It sounds like a lot of work, but it’s really not.
Hunt notes that Freedom Accounts can be a great marital aid. By giving each partner a Freedom Account, both spouses can have their own pool of money to budget independently.
This sounds like a viable alternative to a standard emergency fund. I don’t plan to implement a Freedom Account for myself — I like my current system — but it’s something I would have considered during the three years I was working to pay off my debt.
Addendum: Several readers have noted that Hunt’s method is a little outdated. A modern way to do this would be to open an account at ING Direct. Because ING Direct allows you to create multiple accounts at no cost, you can have one for each of category.
Source: getrichslowly.org