Why an Occasional Expense Fund is more important than an Emergency Fund – Part 1 of 2
If there is one missing piece I have seen in the process of creating a budget or spending plan, it is planning for those irregular expenses. We all know what an emergency fund is but not everything outside of regular monthly expenses is an emergency.
I decided to start this post off with a couple of definitions, compliments of Investopedia, online.
Occasional Expense (or Reserve) Fund
A reserve fund is a savings account or other highly liquid asset set aside by an individual or business to meet any future costs or financial obligations, especially those arising unexpectedly. If the fund is set up to meet the costs of scheduled upgrades, less liquid assets may be used.
A reserve fund sets aside money for covering scheduled, routine and unscheduled expenses that would otherwise be drawn from a general fund
I know. This contradicts what I said above. And I will respectfully disagree with the ‘especially those arising unexpectedly’ comment, as, in my opinion, the occasional expense fund is specifically for expected expenses
An emergency fund is a readily available source of assets to help people navigate financial dilemmas, such as the loss of a job, a debilitating illness, a major repair to home or car—not to mention the kind of major national crisis the coronavirus pandemic has created. The purpose of the fund is to improve financial security by creating a safety net of cash or other highly liquid assets that can be used to meet emergency expenses. It also reduces the need to either draw from high-interest debt options—such as credit cards or unsecured loans—or undermine your future security by tapping retirement funds.
An emergency fund should contain enough money to cover between three and six months’ worth of expenses, according to most financial planners.
I do like that they are referencing the number one benefit of an Emergency Fund … aside from the peace-of-mind aspect, of course, that it helps break the dependency on credit
So where does this fit in to the budgeting process? To answer that question, I need to reference my one ‘budget’ blog post which does not refer to a budget but refers to a ‘spending plan’ and simplifies it. The 3-step simple spending plan
It focuses your planning on the three areas that need attention:
(1) Your fixed expenses
Definition: “any expense that does not change from period to period,” such as mortgage or rent payments, utility bills, and loan payments. The amounts may vary slightly, which may be the case with utilities, but you know they are due on a monthly (or close enough) basis.
(2) Your savings
Which can also be broken down into three parts:
- Occasional (will be discussing this in depth in this post)
- Emergency Fund (as indicted previously, you can set a goal to have a certain dollar amount or income amount saved)
- Goals (vacation, retirement, vehicle purchase, home renovations, replace your computer or water heater etc.)
- Simply figure out how much you need to save, when you need to save it by, and divide by the number of months you have left until that date. This will indicate how much you need to save each month. These types of savings are not meant to be touched until that event happens.
(3) Your Spending
Basically, this is what’s left and is for everything else. Also referred to as ‘discretionary spending‘, because you can decide, mostly, what you will spend on them. For example: groceries, gas, dining out, entertainment etc.
** Watch for tips below on how to effectively manage you’re spending amount **
Some expenses are harder to determine than others. You will have to make your own judgement call on these. For example, smoking could be a discretionary spending expense and could vary depending on how much money you have to spend, or, you could have a much defined habit with little to no room to spend less and decide that it is a fixed expense.
The 3-Step Simple Spending Plan really is a fool-proof system, unless you do not have enough income to cover all three AND you use credit to supplement your income (meaning you spend more than you make by relying on your available credit to cover the shortfall).
Please don’t do that. It’s a recipe for disaster!
For the purpose of this blog post, we are giving all of our attention to the occasional expense fund.
The following are some useful tips for setting up your Occasional Expense Fund:
Step 1 – Identify your occasional expenses
Definition: Occasional or Irregular expenses are costs that come up throughout the year, that you need to budget your money properly for or else you’ll find yourself reaching for a credit card when those expense comes up. You must save for these expenses in advance, and not feel guilty when you spend the money. Consider it “planned spending.”
The most common examples are:
- Car repairs
- Home maintenance, oil/wood
- Back to School costs and a myriad of other kids expenses
- Medical/dental expenses.
Simply start with a list of the occasional expenses you have. Remember, these are expenses you ARE going to have, it’s just a matter of when they occur and how much they cost you. It is recommended that you create a separate category for each expense in your spending plan. Don’t group them under “Other” or “Miscellaneous”.
Step 2 – Calculate what you think you’ll spend on each category over the year
There are several ways to attack this….
- If you keep track of your spending you can simply look at your records from last year and use that figure.
- You can simply estimate to start and make adjustments as you determine any variables. (This is a much better starting point than not doing anything)
- You can gather up the info from various sources. For example, the next time you are at the pharmacy or have your vehicle in for servicing, ask for a printout form last year.
Step 3 – Divide that number by 12,
Put the amount in your monthly spending plan. If you don’t use the budgeted amount each month, put the extra money aside until you need it. We will talk about this more in the second post (watch for it next week). I the meantime, some homework…
Prior to Part 2 of this blog being posted, I encourage you to complete the Occasional Expense Account – Planning Sheet – blank and set up your own Occasional-Expense-Acct-Log-blank.
If you would like to see an example of each, you can download them here:
I’m also including a downloadable blank Spending Plan – 3-Step Simple Spending Plan Template that you use to begin to create your per-pay spending plan (there is an Occasional Expense Account Log on tab 2 of this document as well).
Have fun and watch for next week’s post on how to pull this all together.
aka Dr Debt
(Licensed Insolvency Trustee, Allan Marshall & Associates Inc.)