Mary Hunt has popularized a method of budgeting that I absolutely love: Freedom Accounts. Over here in the world of YNAB, we call those things “Rainy Day Funds” – either way you name it, Mary’s advice to set up freedom accounts is spot on.
A freedom account is basically a fund that you build up over time to help you pay for big expected (or unexpected) bills. I suppose the word “freedom” in there is pretty applicable. Most of the time if people don’t plan for these large purchases, they end up taking on credit card debt – which is the antithesis of freedom.
According to Ms. Hunt’s advice, you should set up freedom accounts for things like your car insurance premium, Christmas, birthdays, property taxes, health insurance premiums (especially if you do this privately and not through an employer), vacation, and – I’m not sure she says this – but I’d throw a vehicle in there as well. Yes, you can save and pay for a reliable vehicle with cash.
Bear with me as I throw a bit of the YNAB Personal Budget into the fray here, but it has this “freedom account” idea built right in. For instance, if your car insurance is due every six months, and the bill is $300, you’re going to need to budget $50 into your Car Insurance freedom account. In six months, if you’re true to Mary Hunt’s advice, you’ll see a $300 balance in that account and you’ll be able to write the check with no problem at all. YNAB tracks that accumulation for you with ease.
You can use freedom accounts for just about anything. Remember, I mentioned above that they can be both anticipated (car insurance premium) and unanticipated expenses (a new transmission).
Case in point: my wife and I haven’t needed car repairs for our Chevy Prizm for several months. Well, actually the air conditioner is broken, it’s leaking freon, but it’s been Winter here for the last several months so we haven’t needed to repair it. At any rate, even though we haven’t technically needed to spend anything on repairs for the last long while (knock on wood), we know that it’s going to happen. That’s just a fact of life. As a result of facing the music of reality, we’ve been quietly budgeting some money into the car repairs freedom account each month. It has a nice balance built up now and it should get us through a moderate repair without having to touch our emergency fund.
In applying Mary’s advice, you might be asking yourself what you should be doing with that money while it’s waiting, ready to do something for you. I use the rule of thumb that if the expense is going to happen within eight months, I’m going to leave it in the checking account. If it’s something annual (such as Christmas) you could benefit from getting a competitive interest rate at an online bank such as ING. Actually, the great thing about ING is that they let you open about a bazillion inter-linked accounts with no hassle at all. You can set up separate automatic transfers between them, from your checking, to your checking, etc. The sky’s really the limit there.
Going back to our car insurance example, if you wanted to make a bit (and it would just be a bit) of interest from the money you’re stashing away in your freedom account for car insurance, you could do the following:
- Setup an ING account with the minimum $1 required deposit (the setup is all online, it’s quite slick).
- Setup an automatic withdrawal from your checking, to your ING Car Insurance account, for $50. Make sure it happens monthly.
- Setup another automatic withdrawal from your ING Car Insurance account to your checking account for $300 just before the next bill due date
…and walk away. Now that’s automated baby! Currently, ING doesn’t let you schedule recurring items with less of a frequency than monthly. You would have to go in every six months and set the new date for the withdrawal. Also, you’d need to remember that there is a 2 to 3 business day lag for the money to actually land in your account (they seem to be faster when taking it out…hmm…) – don’t cut things too close with the due date of your bill and the arrival of your money.
This is one way to take Mary Hunt’s advice and put it into action. The freedom account takes the peaks and valleys of your money situation and smooths them into a nice, level, walk in the park. Brainstorm what possible things could represent freedom accounts for your personal finances. You can use YNAB to help you track it with a few minutes each month, and you can use ING to help you carry out your budget automatically.