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Weekend Edition

I’ve decided to move away from doing regular posts on the weekends, instead I’m going to give a quick recap of this week’s feature content.

I’ve gotten some great feedback from several people telling me how much they like the blog – I’d love to hear from you too.  That kind of encouragement makes it much easier to persevere as this site gets more mature.

May 16, 2009 | Filed Under Emergency Funds, Finance, Money

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Nothing will be fine?

I was reading Dooce.com the other day and came across this quote in an piece about remodeling a bathroom that turned into a catastrophe:

This reminds me of the book I want to write about remodeling. It would go, “Nothing will be fine. Now go re-read that first sentence. The end.”

I think this applies well when you’re talking about more than just remodeling your bathroom.  Think about it – when was the last time things went exactly as you planned?  I can tell you that I don’t remember the last time everything came out perfectly, how about you?

I think this is a great reason to make sure your financial cards are in order.  If you read the rest of the piece on Dooce, you’ll see that this whole experience for them was a bit of a debacle.  They weren’t prepared, but worse, when things went wrong, they didn’t have another plan.  Make sure you have a plan for when things go wrong.

You don’t have to cover every possible contingency, you just have to have the ability to be flexible.  How can you be financially flexible?  Don’t live paycheck to paycheck.  Pay off your debts.  Save for a rainy day.  That’s it.

Seriously.

Have you ever been in a situation where you weren’t prepared for what you were getting into?  I had an experience like that in 2007 when I bought my condo.  I thought I was all smart, buying a piece of property that was already down 20%, thinking the real estate market was going to rebound and I would make a killing.  I didn’t.  My place is great, but I wish I had continued to rent.

Yeah, that’s right Ryan, I should have listened to you.  So sue me.

I wasn’t prepared for my property value to continue dropping.  I wasn’t prepared to pay for a plumber to come in when the toilet broke.  And I wasn’t prepared to do the maintenance required to keep up a place.

But guess what?  Everything will be fine – I’m prepared now for all of those things, even if it is a couple years too late.

May 15, 2009 | Filed Under Emergency Funds, Finance, Money

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Where should I keep my emergency fund? And other questions…

Over the past few days, we’ve gone over your personal economy and figured out how big your emergency fund should be, but we haven’t necessarily discussed how to fund it, where to keep it, or anything like that. I have some thoughts on this as well that I’d like to share with you.

Where should I keep my emergency fund? Emergency fund money should always be in a safe place – that means something that is FDIC or otherwise insured (like a CD, Savings, or Money Market account). It’s okay to have it slightly tied up, as long as you follow the following rules:

How should I fund this account? I say this should be your primary savings goal after funding your dream. Your percentage may vary, but currently I am dropping about 5% of my monthly income in this account plus a bit to cover appliance breakage at my condo. When I get fully capitalized, I will cut this back to an amount equal to my balance * my raise from last year. So if I had a fully capitalized emergency fund at $10000, and I got a 5% raise last year, I would be adding $42/month (10000*.05/12) plus whatever I decide my appliance liability is for the year (I usually go with 1/12 of a mortgage payment a month, but that can shift depending on the size of your house and what your HOA will cover). Why? Because that’s my personal inflation rate, and I need to keep my emergency fund up with my current earning potential.

Appliance liability, what is that? Remember that 10% I told you to add in my post about figuring out what your MME (Minimum Monthly Expenses)? That was to cover unexpected housing expenses like a broken toilet or refrigerator. That qualifies (in my world) as an unexpected expense and is paid for out of my emergency fund. But since I know every two or three years I’m going to have to spend money on something like that, I add a bit of extra money to my emergency fund as a hedge. The worst case scenario then is that I have more money in my emergency fund than I actually need – that’s a problem I can live with.

Personally, I feel like the emergency fund is just about the most important part of a person’s finances, because it gives them the freedom to take some risks and know they’ve got a backstop if something goes wrong. The last thing anyone needs is to lose their job, their car, and their house all at once because one bad financial domino crashed into another.

May 13, 2009 | Filed Under Emergency Funds, Finance, Money

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How big should my emergency fund be?

The emergency fund, i.e. that money that pays the bills when your job isn’t (because you are out of work, have gotten seriously ill, or had some other sort of financial setback that required some additional liquid capital), is a big part of my personal focus in the world of personal finance. I will be the first to admit that my fund is less than fully capitalized, which makes me a bit nervous, and by the end of the year I would like to to be significantly larger than it currently is now.

One of the questions I have been asking myself over the past few months is exactly how large it needs to be, and I’ve come up with some guidelines on how large it needs to be. The first step is figuring out your minimum monthly expenses (MME). If you are a renter (good for you) it’s your rent plus any utilities and insurance you can’t imagine living without and whatever the minimum payments are on any commercial debt you might have. If you’re a home owner, its your minimum mortgage payments, plus utilities and insurance, and the minimum payments required on any other debts you have, plus 10%. Why +10%? Because if a pipe bursts in your house you will have to call a plumber, while a renter can make the landlord cover those costs.

If your rent is $500, you have another $300 in utility and insurance payments (don’t forget health and car insurance – you can find out what your COBRA payments would be from HR at your employer if you don’t have that information on hand), and have a car payment of $350, making your fixed expenses $1150/month. If you own, have a $500 mortgage, $400 in utility and insurance payments (don’t forget to include that HOA payment in here), and a $350 car payment, your fixed expenses are going to be $1325 after you factor in the ‘plumber’ money.

Now, figure out what your monthly food bill is (include going out to lunch at work, date night, etc), multiply that by 2, and add that to your fixed expenses. This will give you a bit of play money (you don’t want to have to eat peanut butter and ramen noodles if you don’t want to) without going overboard. If you spend about $250/month on food, that’s an extra $500 you need to add to come up with your MME.

Okay, now we know how much money it would cost us to subsist for a month. For our renter, we’re talking $1650/month and for our home owner, we’re talking $1825 a month. Your numbers will probably be dramatically different than these, but we’ll use these going forward anyhow. Now we need to figure out how many months we need to have on hand.

Assuming you aren’t going to get fired for cause, you can count on some unemployment money to help you through a work interruption. Do NOT include that in your emergency fund calculation! That money will help you stretch things if you have the misfortune of not finding another job for a significant period of time, but what if you have to quit to take care of your ailing mother? That money won’t be available to help.

I believe that everyone should have at least three months of living expenses on hand. But just because three months is enough for some people, that doesn’t mean its enough for you. Here’s a quick way of determining how many months you want to keep on hand (start at 3).

Then, I want you to add +1 month for every person directly dependent on your salary (non-working spouse, each child, elderly parent, etc). I also want you to add a month if your personal economy score (link) is less than 50, and subtract one month if your personal economy score is above 80. I wouldn’t go below three months.

Lets assume both our renter and our home owner have all the same answers except to the mortgage question, and the renter came up with 5 months while the home owner came up with 6 months. That means that our renter would need an emergency fund of $8250 to be fully capitalized, and our homeowner would need $10950.

Being fully capitalized doesn’t mean you ‘have enough’, but we’ll go over that in another post. What do you think? Am I crazy? Leave a comment and let me know.

May 12, 2009 | Filed Under Emergency Funds, Finance, Money

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