Sunday, June 10

Is My Reserve Fund Approach Any Good? A Debate in Three Acts

PRELUDE...
I was lamenting to a friend the other day that the art of debate is dying in our society. I'm talking about the kind of debate where the opponents make points and counter points on an issue and fight hard about it, but don't take it personally and are still friends when the the debate ends. It's the kind of debate where winning isn't about changing your opponent's mind, but about putting forth the best possible argument, while poking holes in the other person's case.

THE OPPOSING POSITION...
Anyway, it is in this friendly spirit that I am going to defend my reserve fund approach against the challenges set out by Riscario in a recent post and comment. To summarize, he makes the following points:

  1. A statistical approach does not work well for a single home (works better for multi-unit condo). Items will last longer or fail sooner than the schedule indicates.
  2. Budgeting at this level of detail is boring and does not work. Better to build up an emergency fund using x% savings rate.

MY REBUTTAL...
I believe that the intention of my "reserve fund study" has been misunderstood:

  • What Am I Proposing? This is not a budget for future spending. This is a plan for saving. The end result is a single number that tells me how much to save.
  • A Simpler Way? The x% savings approach might be good... if we knew what x was. This approach provides a way to determine what savings rate may be needed.
  • A Statistical Approach? By including as many expenses as I can think of I do receive some spread of risk. But ultimately, the future use of this money is flexible and up to me. If my fridge is still in good condition in 10 years then I can wait another year. If my roof goes before I've finished saving for it then I will have to make up the shortfall. But it will be less painful than if I hadn't set up a reserve.

In summary, my reserve fund approach is really a way to help the large expenses be spread out over time. We all know that the best thing is to put aside a bit of money every month. This approach allows us to answer the question "how much?" with more ease and accuracy. It does not dictate when or how the money will eventually be spent.

Thanks to Promod for his thoughtful comments on this and other topics. I respect his expertise and appreciate his contributions. But in this case... I must debate!

3 comments:

FourPillars said...

I don't think it's a bad approach.

If you are making decisions about spending during the year then you want to know what your basic and upcoming costs are. If you don't know all the costs then you might think you have more spending money than you actually do.

One other point - I'm not sure of the relevance of budgeting for items that aren't going to happen for a long time (10+ years) since most people (especially younger) probably won't be living in the same house by then.

Mike

Thicken My Wallet said...

I am recently getting caught up on your blog- that's some great analysis you have going!

However, I do agree with Four Pillars- budgetting for items which are 10 years out may not be the most productive of exercises. I live in a condo and reserve fund contributions tend to be more for items which at 0-5 years out. To be Stalin-esque about it, you may want to do rolling 5 year plans/budgets or you could be tying up money which you can otherwise use to invest.

One other point, for any matter which requires hired labor (i.e. most people I know hire a roofer), you should generally factor in a 15% over-run in costs.

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