Figuring out how much money you need in an emergency fund and for the medium term is not easy. Knowing where to keep it is yet another challenge. Getting there is also a question that needs an answer.
How I got the emergency fund.
Many many years ago, I was a saver. I automatically saved each month a part of my salary base upon my budget that I aside made. Nothing fancy. I did this because I have learned from parents that I need to take care of my money, not spend it all: basically: life below my means. They also talked me into pension saving. Some good lessons I got there.
Now, many years later, I am really happy that I did this. It allowed me to start the FIRE journey without having tho worry about my emergency fund. It is already there.
Why to save for the medium term expenses?
That being said, as part of our total cash fund, I also count the expenses that I foresee the coming 2/3 years. This can be a renovation of the kitchen or bathroom, maintenance of our roof (like we recently did),… We actually have a long list of items in our mind that we want o do with the house and travel.
It is not the goal that all our plans covered by this cash fund. Some will have to come out of the F-fund. But, the overall ambition is that we know these planned expenses a few years ahead and that we make sure the money is there on time. This way, we do not need to worry about the current price of the assets we have, we do not need to sell below the value and we can sleep better. Maybe we miss out some return in the long run, I am ok with this.
How do we do this?
This medium term fund is not there yet. Actually, sometimes it is there, then it is gone. At the time of writing, it is slowly appearing again.
It appears by automating most of the work. Each month, when our salary hits our account, the automation that banks offer kicks in. The salary is split into different parts: personal budget, family budget, invest budget and saving budget. This is all done without us having to move a finger. We can do this because we have a budget that we actually are comfortable living on. The rest is easy:
salary – family budget contribution – personal budget = money to save and invest.
We actually go a step further: we have a fixed amount that we put into the savings account and into the investing account with the broker. This way, all is done, without emotion of the day, with being impacted by the market noise. It just happens.
The account fills up each month and when the day arrives to remodel a kids room or maintain the roof, then we can just access the money, no matter what Mr Market is priced at that day. Peace of mind rules
How is it accounted for?
In the savings rate calculation, this money is not counted as saving. Funny, isn’t it? The reason is that this money is actually not saving. It is just being parked away for a future expense. This has some advantages
- The money will be spent later. By not counting this budget, it does not inflate our savings rate. Why is this important? The higher the savings rate, the sooner you can expect to be free. As this money will one day be spend, It feels better not to count it as saving.
- By not counting it a saving or F-money, I do not need to worry about the expense at the time that it happens. I do not impact my savings rate with a big expense. This would probably lead to negative saving at that time.
- By not counting it as a contribution to the F-money, our net worth does not take a hit if we spend the money.
But I am not naive. I do know that at one moment in time, our cash account will not be big enough to cover some luxury expenses without eating too much into the emergency fund. The day will come. Some of these days are actually already planned in my FIRE date calculation. the tool allows for such an expense to be entered. Its not perfect, but better than nothing.
By using the above system, that is based on a budget and automation to pay ourselves first, we have already today some freedom to make bigger expenses, or to adjust life so that we get what we value most.
It is key to note that you need to have budget that let you live well below your means so you can have a decent saving rate.