What’s a Freedom Account? What’s a Rainy Day Fund? What’s a Sinking Fund?
They’re all the same thing. Mary Hunt coined the phrase Freedom Account, I (probably did definitely didn’t) coin the phrase Rainy Day Fund. I’m not sure who got Sinking Fund. Had I known about Mary Hunt’s Freedom Accounts before making YNAB, I wouldn’t have bothered trying to coin anything.
[Update: Thanks to Adam for taking the time to see if I did coin the term ‘Rainy Day Fund’. Apparently it’s something state governments have been doing for a while – to buffer against times when revenues are lower.]
The gist of it is that you set aside a fixed amount of money each month to prepare for larger known expected or unexpected expenses of a fixed or variable amount.
For instance, I know the car will eventually need repairs. It’s a known expense. How much will these repairs cost? I have no idea (hopefully very little). Known expense, variable amount.
I know that our life insurance premiums are due annually. It’s a known expense. How much will the premiums cost? We have term insurance, locked in for at least a decade, and it comes to $840 per year. Known expense, fixed amount.
Based on past experience, let’s say we spend $2,000 per year on car repairs. That means I need to be socking away $167 into my Car Repairs account (or YNAB category, but we’ll get there). For the life insurance premium, $70 per month means we’ll be able to pay for that premium easy-breezy. And now we have the Freedom Rainy Sinking Account Fund. All set up and ready to go.
JD over at Get Rich Slowly wrote about a month ago about Freedom Accounts in depth. Apparently Mary Hunt originally advocated setting up a separate checking account and then keeping a lot of separate “accounts” within that checking account for all of your Freedom Accounts. (Also, see MoneySpot’s great article on Freedom Accounts.)
Get Rich Slowly Savvy Readers were quick to comment that companies such as ING let you set up an unlimited number of accounts — all for free — that bear some interest. Transfers to checking can happen quickly and you can set up auto-funding with a few clicks. I’m a huge fan of ING for this very reason. You can read what I wrote about ING and be sad that the rate is no longer as high as it once was (but still better than your checking account).
(Thanks to Sean, Leslie, and Inabag for mentioning YNAB in the comments. I owe you three lunch. Also, a bit less thanks to Michael for claiming that the “YNAB Team” made all those comments. Would still buy you lunch so I could figure out why you didn’t like YNAB so much. We’re open to feedback!)
The beauty of the YNAB system is that all of these accounts can be easily managed right in the Budget. If you set up a Car Repairs category, you just “sink” money into it every month and watch the balance rise.
In order to keep the number of physical accounts down at our household, I only use a separate account for our New Car Fund (I wish). All of the other accounts are small enough I don’t bother earning any interest. It’s your personal call though.
At the end of the day, implementation details aren’t the important part. What’s important is that you’re looking ahead and actively planning what your money is going to do and when. You’ll then find that all of those “emergencies” that used to knock you off your financial feet are now not a problem at all.