Saving for Recurring Large Purchases

Many individuals can do a good job of living within their means during normal months. and even saving up for vacations.  What normally causes people to go into debt are the large expenses that come up infrequently but still can be predicted with a little foresight.  This includes things like replacing a car, paying for major home repairs like a new roof, paying for the large medical and dental bills that come up from time-to-time that aren’t covered by insurance, and the replacement of furniture and other household items that wear out over time.
Once in debt one can never really get ahead of the curve since once one loan is paid off something else will be needed, causing another loan to start.  Because of the interest being paid, you will actually end up paying far more for the items than you would have if you had the cash to begin with.  This causes you to get further behind.  Have a run of bad luck, and you could be looking at a bankruptcy, or at least a difficult time putting money away for retirement.
The only way to avoid this scenario, which is the norm for most households, is to get out ahead of the expenses.  This involves putting money away right from the start, and continuing to put money away each month so that the funds will be available when the need arises.  By doing so, not only will you avoid interest payments, but you will be in a better position to negotiate price reductions since most people will give a discount for cash.  The time to start is right after you move into that new home and you don’t see the need to replace anything soon.
The first step is to list the recurring expenses along with how often you expect the expense to occur.  As an example, in the table below are listed some of the normal large expenses a family would expect.  The price is the full price for the item, the years column gives the approximate frequency in years at which the expense would occur, and the monthly cost is the price per month.  As can be seen, it is assumed that one replaces their car with a quality used car every six years, costing about $8000 (assuming that one receives $1000-$2000 through the sale of their car).  Normal items like roofs, air conditioners, and water heaters are also included.  Medical costs are also included, since one should expect a few trips to the emergency room, uncovered procedures, or some dental work.  Finally, things that wear out in the home like floors, couches, and appliances should be budgeted.
Item Price Years Monthly Cost
Car $8,000.00 6 $111.11
Roof $10,000.00 20 $41.67
A/C $6,000.00 10 $50.00
Water Heater $500.00 5 $8.33
Medical $5,000.00 5 $83.33
Appliances $5,000.00 10 $41.67
Furniture $5,000.00 10 $41.67
Floors $5,000.00 10 $41.67
Total $419.44
Once this is done, the monthly cost can be calculated by dividing the cost by the number of months between the recurrence of the expense.  For example, the car cost of $8,000 would occur every 6 years or 72 months, so the monthly cost would be $111.11.  Notice that this is less than a typical used car payment since you are not paying interest.  You would also do better on both the car purchase and the car sale by both buying the new used car and selling your existing used car via private party, resulting in a savings of around $4000.
Once you have determined that total monthly cost of all of the items, simply sum them.  This is the total amount you should be putting away each month.  In the example, one would probably round up to $450 to provide a little cushion.
Money for these items should be placed in a separate savings account each month and only be used for their intended purposes (no taking vacations with the money).  By combining the savings for all of the expenses into one account, you have the effect like insurance where a large sum of money will be built up quickly, reducing the risk that expenses will exceed the cash available.  For example, with a savings rate of $450 per month, one would be able to pay cash for a water heater by the second month and replace an air conditioner in less than two years.  Even a car could be replaced after only about three-and-a-half years.  These can be unexpected, budget crushing expenses when one is living from paycheck-to-paycheck, but they would be a minor inconvenience if one has been putting money away.
As the balance builds up, one should start putting some of the money into CDs which pay higher rates, and eventually putting some of the excess into mutual funds.  For example, once one has more than $10,000 in cash, it would be fairly safe to start putting the excess into mutual funds since one could cover most of the unexpected expenses easily.  Just remember to start selling off shares of the fund when prices are attractive if a  new roof or car is coming up within the next couple of years since stock prices can be unpredictable.
Take some of the stress out of your life and keep more of your money by planning ahead and saving up for your big expenses.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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