E-funds and Freedom Accounts
Several days ago I received an email from a reader named Mindy. She had some questions regarding the different types of savings accounts which I mention on this site:
Since I think it's quite possible that others might have these same questions floating around in their brains, I would like to discuss the topic publicly.
By the way: When I talk about “savings,” I’m just using that as a general term to encompass both my Emergency Fund and Freedom Account. One could have a “Savings Account” for more discretionary items, I guess, like kick-butt Nikon cameras, family vacations, and so on. Or one could just set this up as “Noncommitted Funds” inside a Freedom Account. It’d work fine either way.
Now when I say I want to have, say, $9,000 set aside in my e-fund, what I really mean is that that’s the total I want to see when I add my Emergency Fund account to the portion of my Freedom Account that is classified as Noncommitted Funds. I may have $1,300 saved up in Freedom Account subaccount “Car Repairs,” but these are Noncommitted Funds. If I'm in a really tight money spot, then I could always slide that money over to use for extra-large house repairs if I have to do so.
I divide my Freedom Account savings into “Committed” and “Noncommitted” subaccounts because (1) I just like the idea, (2) it helps my brain compartmentalize things, and (3) ING Direct pays me a much better interest rate than my credit union, so I keep as much money there as is reasonable and efficient. In reality, if money is saved as “Noncommitted Funds” in my Freedom Account, and it has no specific intended purpose or set date for expenditure, then it’s really just a branch of my total e-fund.
I may be entirely off-base by looking at it this way. Maybe what I SHOULD do is have four months’ worth of expenses saved in my Emergency Fund in ADDITION to the total that’s in my Freedom Account (counting both committed and noncommitted funds). If that’s the case, then I’m a LONG way from where I ought to be.
Does all that make sense? My wife continually asks why I make this so complicated for myself. My answer is that it works for ME. I am a control freak. I like assigning purpose to my money — sort of tidying it all up in desk drawers, I guess.
I just glanced back at Mary Hunt’s recommendation for a “Contingency Fund,” and she suggests keeping a flat $10,000 in that. “Financial experts typically suggest a family needs the equivalent of three to six months’ living expenses in reserve,” she writes. “I find that recommendation too nebulous and prefer to … suggest a fund of $10,000. That seems about right for the average family. If your monthly expenses are high, however, you should adjust the amount to cover what you would need to live for a full three months without any income.”
So it is very akin to Dave Ramsey’s “Emergency Fund.” And Mary says you should have the “Contingency Fund” in ADDITION to the “Freedom Account.”
But hang on. She goes on to say: “Think of your Contingency Fund as your personal debt insurance. Its short-term purpose is to give you an alternative to using credit to cover emergencies like auto repairs and medical bills for which you are not otherwise prepared.” So really, it DOES encompass what I call my “Noncommitted Funds” inside my Freedom Account. I’m not so far off after all!
As far as “what comes first,” well, that depends which money guru you want to follow. If I had to suggest a plan for someone right now, it’d be pretty similar to Ramsey's "Baby Steps," and would read like this:
1) Figure out your irregular, intermittent expenses; i.e., the “Committed Funds” part of a Freedom Account. Determine their equivalent monthly amounts. Start depositing this money monthly into your Freedom Account, just as you would any normal monthly bills.
2) Step away from the cliff: Save $1,000 as quickly as you can. Meanwhile, make minimum payments on your debts. This is your beginning Emergency Fund.
3) Pay off the debt. Pay off the debt. Pay off the debt.
4) If something happens and you have to dip into the Emergency Fund, go back to (2).
5) If your employer offers some sort of decent match on a tax-advantaged retirement account (like 401k), contribute just enough to get the maximum match.
6) Complete your Emergency Fund savings and fill out whatever else you need to in your Freedom Account. As for the e-fund, target whatever amount makes you comfortable … $10,000 flat, or 3-6 months’ worth of expenses.
7) Max out your tax-advantaged retirement savings vehicles.
And so on.
As always, if anyone has questions or comments, feel free to email me!
Michael | March 16, 2005
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