What are contingency funds? And why should every family have them? Learn why contingency funds are the key to escaping paycheck to paycheck living!
Watching the balance on our biggest credit card shrink over the past year has been…how should I put this? Ah-maz-ing! Our main goal in our #yearofno has been to knock out this debt every chance we get. It’s gone so well.
But there is one thing that I wish we had done differently. Something that could have made a bigger difference in our debt payments.
They’re called contingency funds. It’s a genius (but uncomplicated) idea that prepares you for those nagging expenses that add to debt.
So let’s dig into the world of the sinking fund method. What is it, ways to make it work for you, and more. This can change your life in a fantastic way!End the worry about unexpected bills forever with the sinking fund method.Click To Tweet
What Are Contingency Funds?
Emergency funds are important, but they’re a bit different from contingency funds. Emergency funds are good for covering expenses that come out of nowhere and can bankrupt you in no time. Things like a sudden layoff, an accident, or a surprising health discovery are emergencies…which are different from annoying bills.
Contingency funds are money in you keep in an account (or a set of envelopes) that’s set aside for specific expenses that pop up and give you a headache. Those once-per-year insurance bills. Unpredictable car repairs. Garbage bills that get paid every 3 months…though you can never remember exactly which month they’re due.
When those bills come in the mail, do you get a sense of dread in the pit of your stomach? Maybe you can cover this bill, but it will be a stretch. Or worse, it’s going to have to go on a credit card (again).
The job of a contingency fund is to keep that sinking sensation away. Instead, you’ll open that bill and know right away that you have the money to cover it.
How to Set Up Your Contingency Fund
You can set up your funds a few different ways. One simple way is to have envelopes in a drawer labeled with individual categories. The money is at the ready when a bill comes due.
Our preferred method is to have a separate checking account. We use Capital One 360 because they don’t charge fees. (You don’t need direct deposits to keep the account free, either.) The best reason to open a separate account is because if you don’t use this account to pay regular bills, the money is out of sight, out of mind.
You can keep a debit card for this account, or you can just set up online bill pay. Avoid ATM fees by doing a cash advance on your debit card inside your local bank. (Capital One 360 won’t charge you for doing this.)
Once you open your new account, create “imaginary envelopes” for yourself. This is simple to do in a spreadsheet or a spiral bound notebook. We’ll talk more about this in a minute.
Contingency Fund Example
The next thing to do is list everything that deserves a line in your contingency fund. You might not have the money to fund it all yet, but you should still list all the categories you can think of. (Yes, even that dream vacation to the Caribbean.)
Some contingency fund category suggestions include:
- bills paid less often than monthly like trash or water
- car taxes or tags
- insurance bills
- school or membership fees
- car repair and maintenance (including tires and oil changes)
- birthday gifts
- home maintenance
- appliance repair or replacement
- healthcare copays (though you’re better off with an FSA or HSA)
- big expenses you are expecting soon such as braces or furniture replacement
- extra reindeer food in December (Just checking…)
- anything else that applies to your situation
Contingency Fund Calculation
Next, let’s to talk numbers. (I’ve never been a math fan, so I always pull out my trusty calculator.) Next to each category you’ve written, determine how much money you spend on that item per year. Some will be straightforward. Bills that usually stay the same price, but come less often than every month, are an easy way to start. (Looking at you again, garbage bill.)
Others are more elusive. How long has it been since you bought tires? How often do you get oil changes? If you use a debit or credit card for these things, you can search your statements to get a better idea. Otherwise, an educated guess is good enough. The goal is to get it set up. You can tweak it as you go.
You might notice that the numbers are climbing. It might even exceed any price you could ever hope to keep up with. I noticed this in my own budget. Maybe that’s why we can never seem to get ahead?
So put your items in order from most important to least important. We’ll fund as many accounts as we can before the money runs out. Filling the vacation and Christmas funds is wonderful, but a reliable vehicle should come first. Remember, though, that the fun stuff should still earn a place on your chart. Once you get ahead, you’ll be able to fill them, too.
Now you’ve got a yearly amount down for each category, so divide that number by 12. That’s how much money you’ll need to put into the account every month to keep up with these expenses. If you’re paid biweekly and want to divide it by 26, do that.
Now go down the list and see how many categories you can fill with the amount of money you can afford each month. If you don’t like what you’re seeing, be sure your categories are in order. Most important items at the top. Don’t get discouraged!
How To Track Your Money
Remember when I told you to keep track of your categories by using “imaginary envelopes”? Here’s how you do that.
Get a spiral notebook or set up a spreadsheet to record your categories. Dedicate one page to each category that you listed above. Whenever you deposit money, mark down how much you put into each category.
- You might decide that the first category is the most important, and you want to fill it as fast as possible. So you’ll put all of your money into that page.
- Or you may decide that the first 3 categories are all pretty important. So you’ll divide the money you have available into thirds, and put one chunk into each of the categories.
- You could even decide to put half the money into the first category and divide the rest equally into your other categories.
You know your situation best. You’ll have to decide how to layer your money to match your situation. As you spend from this fund, write down any expenses on the page they belong to.
You could simplify this by opening one bank account for each category, which is totally possible with Capital One 360.
Contingency Funds Spreadsheet
If you prefer a good spreadsheet (Me! Like the proud nerd I am.) I’ve put one together for you. You can access this in Google Sheets (similar to Google Docs). Click here or on the sheet below, make a copy, and save it as your own. You can move around your own categories. Simply put in the amount you can afford monthly. Type in your categories and how much each of them cost per year. The sheet will take care of the rest of the math.
Play with it a bit until you’ve filled as many important funds as possible. Can you do without anything? Can you find a way to increase your monthly amount?
Where To Find the Money For Contingency Funds
Finding the money to fill this account all at once is ideal. Then, when you use the money in a category, you can refill it using the money you would have sent from your check (or extra money you’d been sending to debt). If you don’t have a few hundred lying around to do that, be sure to check out these 30 ideas for saving and making enough money to fill your contingency fund.
Sign up for a fun 30 Day Money Challenge that begins January 1st!
Contingency funds can change your finances for good.
You’re going to love the feeling of confidence you feel with the next irregular bill!
For more reading, check out How to Get Out of Debt By Breaking Up Your Paycheck.
Have you ever saved up for expenses like this?