Tag Archives: money market

Protect Your Future With Sinking Funds

My earliest job as a child was mowing the lawn. One hot Michigan summer afternoon, Superhero Dad decided it was about time for me to contribute to yard work beyond raking leaves in the fall. After a few minutes of coaching on how to prime the gas line, start the engine, empty the mulch bag, and operate the self-propelling mechanism, Dad headed inside and left me to get to work.

Our lawn was average for our neighborhood: one-third acre in size, trees and other obstacles galore, and dusty. I quickly learned to hold my breath when emptying the bag into the backyard compost pile.

After approximately two hours of navigating countless twists, turns, and bumps, and contemplating the treasures I could purchase with my new income, my work was complete. Like any self-respecting nine-year old, I marched up to Dad, who was reading the newspaper in his recliner.

“I’m done,” I said, extending my open hand in anticipation of a rich payment.

“OK. Let’s go take a look,” Dad replied.

After touring the yard and noting the deficiencies in my work, the long-awaited moment finally arrived. Dad reached into his pocket and presented me with a crisp $5 bill.

I don’t recall experiencing any exuberant emotion at the time, though in hindsight, $5 was probably a fair lawn-mowing rate for a nine-year-old boy in the mid-1990s. But I do remember walking to my bedroom, closing the door, and slipping Mr. Lincoln into a manila envelope in my night stand.

Envelopes Everywhere

Like many of my earliest financial lessons, I learned the practice of safe-guarding my money in envelopes from Superhero Grandpa. Grandpa had envelopes for everything, each with a hand-written label, secured behind the solid walls of his safe.

I didn’t know it at the time, but several of Grandpa’s envelopes were intended to save for future purposes. Among the purchases made from one of Grandpa’s envelopes was one of the last vehicles Grandpa purchased: a brand-new 2008 Honda Accord EX-L. The story of how Grandpa walked into the showroom with a brown bag full of cash one day after test driving an Accord is one of my all-time favorites.

My 2008 Honda Accord EX-L
My 2008 Honda Accord EX-L

One year after Mrs. Superhero and I were married, Grandpa approached me and asked if she and I would be interested in buying the Accord; he had already gotten the itch to purchase a new vehicle. We were desperately in need of a fuel-efficient vehicle and had been saving money for months.; yet, at the time, purchasing the vehicle would have been a bit of a stretch.

After a few months passed, we finally had enough money saved to purchase the car. My hand trembled a bit as I sat down to write Grandpa the largest check I had ever written (at that time).

“Can you take me out for a ride in your new car?” Grandpa asked me.

“Of course,” I said. “Where are we going?”

“The bank,” he replied.

Moments later, we arrived at the bank. What I anticipated would be a short, unremarkable trip turned out to be lengthy and memorable.

“I want to cash this check,” Grandpa informed the teller.

The teller examined the check and flashed a stunned look, first at Grandpa, then at me.

“Sir, I have to recommend against keeping this much cash on hand. Would you like to make a deposit into your savings account?” she asked.

“No. I want the money,” Grandpa retorted.

After the teller’s acquiescence and subsequent counting of many $100 bills, Grandpa and I exited the bank. I was terrified that we would be jumped, robbed, and left for dead in the parking lot. Luckily, my worries were unfounded, and Grandpa and I arrived safely back at the house.

True to form, Grandpa immediately removed his new stack of cash from the teller envelope, placed it in a manila envelope, and locked it in his safe, but not before counting it once more, just to be sure it was all there.

The Sinking Fund: An Update to Envelopes

I did not know it at the time, but Grandpa had just added to his always-growing portfolio of sinking funds.

For readers who may be unfamiliar with the term and its application in personal finance, a sinking fund is an account designed to save for specific future purchases. A sinking fund is different from an emergency fund, as its contents are earmarked with an anticipated purpose, while an emergency fund exists to cover unanticipated expenses.

While Grandpa’s approach was commendable, it is advisable to maintain sinking funds in a savings or money market account which is separate from your emergency fund. If you are able to meet minimum balance requirements, it may even be wise to open separate accounts for each sinking fund. You do, however, want to be sure that your money is not eaten away due to senseless fees.

As an alternative, provided you have a sufficiently-funded emergency fund, you could invest your sinking fund money in CDs if you know you’re not likely to need it during the term of the CD. You should be certain that investing the money and losing access to it for the duration of the term will not cause undue hardship.

The Sinking Fund Test: Do I Need a Fund For _____?

The number and type of sinking funds you maintain should be tailored to suit your individual circumstances. The following guidelines and questions are intended to spark careful thought and consideration.

What items are nearing the end of their anticipated utility? (In other words, what items are likely to breakdown or require repair in the next six months to five years?)

What degree of difficulty would be posed if you were expected to live without these items for a set time period?

What upcoming purchases and expenses can you reasonably anticipate and begin saving for with a sinking fund? (Hint: Christmas is in December this year!)

In summary: If an item is likely to soon need replacement or repair, you need a sinking fund for it. If you can’t live long without this item, you need a sinking fund for it. If an expense is anticipated to be due within the next six months to five years, then you need a sinking fund for it.

FinanceSuperhero recommends that you organize your sinking funds based upon priority (Ask: What is likely to break first?) and fund them according to your ability to do so each month. Develop a rough calculation of the projected cost for the item in question and divide that total by the number of months remaining until the expense is anticipated; this is the amount you should budget to save within the sinking fund each month.  Again, place funds in a simple money market account or high interest bearing online savings account, depending upon the amounts in question.

Among many other possibilities, the following items deserve your consideration when developing a list of necessary sinking funds:

  • Vehicle replacement
  • Christmas and birthday gifts
  • Vacations
  • Home repairs (roof, HVAC, sump pump)
  • Home renovations (basement renovation, kitchen and bathroom remodeling, sizeable landscaping or the addition of a deck or patio)

Readers, do you utilize the sinking fund approach? For what types of purchases do you maintain sinking funds? Where you do maintain your sinking funds?

The Car Lease – The Devastating Costs of Luxury

Yesterday, while driving around town to complete errands in my fuel-efficient, three-year-old Hyundai Sonata, I found myself waiting at a lengthy stop light. Naturally, the wait annoyed me to some degree, as I was the only car in sight. However, Moonlight (my wife’s affectionate name for our Hyundai) and I weren’t alone for long, as we were soon joined by a sleek, shiny 2016 Audi A8 Sedan.

Leasing a car may seem smart, affordable, and convenient, but this luxury may be costing you your freedom, retirement, and much more!While I am admittedly a car lover, I must admit that my interest was divided equally between the A8 and its driver. Why? The driver could not have been a day older than 25, by my observation, and naturally, the Finance Superhero in me could not compute many scenarios in which this young man could afford such a fine vehicle.

I know what many of you are thinking:

  • Good for him! This fellow has clearly done well for himself.
  • Did you strike up a friendship with Mr. A8?
  • Age is hard to predict; maybe this hot shot is older than he looks.
  • Weren’t you jealous?

My thoughts:

  • Maybe.
  • No.
  • Maybe.
  • No.

Jealous? While others may have felt envy, I only felt pity.

Yes, it is quite possible that this driver was closer to 35 than 25. It is possible that he is a new partner at a leading law or accounting firm. However, statistics dictate that it is more likely that he is a 20-something who earns slightly above the median US adjusted gross income ($36,841 in tax year 2013, according to IRS.gov). Regardless, I assert that the driver’s income is a variable that pales in comparison to the opportunity cost in driving and likely leasing such a fine vehicle.

I Hope He Likes the Car

Except in cases of significant wealth, the luxury vehicle represents one of the largest financial boat anchors in the lives of Americans. Leasing one – or any car- can destroy your budget, crush your dreams of financial independence, and eliminate hope for a modest retirement.

For the purposes of illustration, let’s assume that Mr. A8 is leasing his vehicle. The current manufacturer lease offer for this vehicle is $899 per month for 36 months with $4,644 cash due at the time of signing. This represents a total cost of $37,008 over three years, or $12,336 per year! For a car!

What’s that? You’re still not convinced that Mr. A8 isn’t getting a fine deal?

Let’s assume that Mr. A8 utilized the $4,644 cash due at signing on the Audi and instead purchased a much more affordable yet attractive vehicle. For example, suppose he found a deal on a 2004 Honda Accord and stretches his budget to $5,000. In this scenario, he would not have any monthly auto expenses, aside from gasoline and regular repairs. This would free up $899 per month!

What could he do with these money? Here’s a suggested monthly breakdown (rounding up to $900 for the sake of simplicity):

$400 placed in a money market account as a sinking fund designated for the purchase of a replacement vehicle when the Accord goes to the junkyard in the sky

$500 invested in a company 401k/403b, up the company match, with remaining funds invested in a Roth IRA

Now, let us suppose that our 25 year old driver’s investments earn an average return (after inflation, the generally-accepted return figure for the S&P 500 is approximately 7%) and is compounded monthly. After thirty six months, Mr. A8 would have just over $20,000 combined in his 401k/403b and Roth IRA accounts, not including any company matching. Additionally, he would have $14,402.22 saved in his money market account (assuming an interest rate of .01%) toward the purchase of a future vehicle. If he continued investing this same amount each month until age 65, he would be poised to retire with investment accounts valued at approximately $1.3 million.

I hope Mr. A8 really likes his fancy car!

Common Objections

Despite the fairly simple math above, some people still love their leased car. I’ve heard many objections over the past several years. My response is usually very straight-forward.

I need a luxury vehicle for work purposes.

I understand that for many professionals, the appearance of a car is very important. However, a 3-4 year old Honda Accord or even 10 year old BMW will get the job done. And these vehicles can often be purchased in great condition, especially if you flash cash to secure a great deal.

I am not handy when it comes to automotive maintenance, so a lease makes sense for me.

This objection rarely rings true. First, very few people are capable of maintaining their own vehicles beyond routine fluid changes, brake replacement, and tire rotations. Leasing a vehicle does not eliminate maintenance costs. And no, maintenance is not free with a lease. You are paying for it, as the costs are built in somewhere.

Second, new vehicles are often subject to repairs that will later be addressed by manufacturer recall. Strategically purchasing used vehicles which have already had these concerns addressed and repaired and have already had their 50-60k mile maintenance performed is a much better way to go.

With a lease, I can drive a new car every two or three years.

Listen. You need to make a decision. We are talking about your vehicle or your retirement! Which do you want more? 65 year-old you will want to kick 25 year-old you in the butt for being stupid and leasing a vehicle when you could follow the simple mathematical plan above and still simultaneously fund your retirement AND drive nice vehicles. And 65 year-old you is likely to get that opportunity, as Apple will probably have invented the iTimeMachine by that point. Don’t screw things up for future you! Don’t walk away – run – if you’re tempted to lease a car.

What are your thoughts on car leases? Does it ever make sense to lease a vehicle? Have you or someone you know ever been burned by a car leaLeasing a car may seem smart, affordable, and convenient, but this luxury may be costing you your freedom, retirement, and much more!se? Share your thoughts in the comments section.