Monday, January 8, 2007

Budgeting for mid range goals

As I discussed previously, I budget for retirement savings and also for midrange expenses, leaving the remainder to handle monthly recurring expenses which I don't track in detail.

Midrange expenses that I need to save for are those such as:

  • Taxes and Insurance that are billed annually or semiannually
  • Major repair items for my house
  • Car depreciation
When I had a mortgage, the mortgage company set up an escrow account to handle property tax and insurance premium payments. Every year I would get a statement showing the balance and expected expenses for the following year (based on the prior year). Then it showed the required monthly contribution so that the estimated minimum balance would be several months expenses.

Now that the mortgage has been retired, the taxes unfortunately are not. Without a mortgage I could drop property insurance but choose to keep it in force. To avoid a big impact to my finances when these expenses come due, I set up my own escrow account which I track in my spreadsheet. Since this works well for housing related expenses, I also track tax and insurance payments for my vehicles the same way. Future expenses are based on prior expenses with an inflation adjustment. The spreadsheet can predict balances based on monthly contributions and estimate a low balance. If necessary I adjust my contribution so the lowest estimated balance is still a few months expenses.

And being a property owner, I don't have a landlord to harass when problems arise. I've had to have the roof reshingled and the central furnace / air conditioning replaced in the last few years. I've been setting aside $100 / month to cover these expenses, and when these expenses came up I was able to handle them without going into debt.

Most people have car payments, and then view the cost of driving a certain distance as the cost of the gas they'll burn getting there ignoring the depreciation on the vehicle. Since I've paid for my last two vehicles outright, I view the cost of driving a certain distance as the added depreciation due to driving that distance, which far exceeds the cost of gas even at $3/gallon. So I estimate the cost (other than gas) to drive a mile as the price of a vehicle divided by 100,000 miles. So a $20,000 vehicle is depreciated in my system at 20 cents a mile, to which I add a couple of cents a mile to handle tires and other maintenance items. Every month, I put my odometer reading into my spreadsheet and it computes how much to set aside for depreciation.

Yes, I know that a vehicle depreciates fastest when new whether driven or not, but since I keep my vehicles for several years it averages out. You might also point out that vehicles should last more than 100,000 miles. True perhaps, but the older the vehicle the more often repairs are needed. With my system I should have enough saved to replace the vehicle after having driven it 100,000 miles.

While my method could perhaps use some refinement, it still has served me well. I know how much to keep in more liquid assets to handle these expenses, and can keep retirement savings separate to be kept in longer term investments. I plan to continue this approach even into retirement, but adjusting as a go along if any changes come up, including lifestyle.