What to do with extra money

[glock35ipsc]

I'm just thinking out loud here, so please bear with me.

We are debt free except for mortgage (30 year, paying as if it were a 15 yr), have 5 months expenses in a money market account, both of us are putting 15% into retirement accounts, and we have ESA's for both kids.

I'm wondering what to do with the extra cash left over that does not already have it's place in the budget, and what I would not consider "fun money."

While the money may not currently be earmarked for anything, it would probably be the money that we accessed for a replacement vehicle, vacation, new appliance, or something of that nature.

Should I put it in the money market account, dump it in a high yield savings account, or put it into a fund at Vanguard? The nature of not knowing when I might want to use this money makes me shy away from any type of mutual fund, but I would like to have a little better return than the high yield savings or a money market account (if that's possible). A year ago I might have looked at T-Bills, but those kind of suck right now.

Any ideas?

[jIM_Ohio]

Great question. Look at your annual budget- is the following accounted for:

1) car insurance (usually due 2X per year)
2) house insurance
3) home owners insurance
4) house repairs/ house improvements
5) car maintainance (oil etc...)
6) vacations
7) medical expenses

then think about the last 5 years- do you have those "every 5 year expenses budgeted"-
1) new tires for one car
2) new landscaping for house
3) medical procedures

the idea is that if you have two cars, once every 5 years something probably happens to one of them. Maybe you need to improve landscaping every 5 years (or something similar- might not be landscaping). As for medical expenses, in the last 5 years have you or wife had any major (or minor?) procedures. Giving birth, emergency room etc...

Then think ahead the next 10 years.
1) new roof?
2) new driveway?
3) new HVAC
4) new hot water heater.
5) new car
6) kids education

Maybe some of those are every 30 years or every 15... but think of large expenses you can expect.

Then budget for them- this is what I am trying to build my current budget to.

New roof is 7k every 20 years (240 months) so 7000/240=$29/month.
New car is 30k every 9 years (108 months) so 30,000/108=$278/month
Medical expenses are $2400/year=$200/month

I then add those things up ($507/month in this example) and I need to set aside that amount each month to cover the "normal" long term expenses.

You said you had 5 months expenses in the bank- good work. My advice would be to match that 5 months expenses in a more moderate investment- I use PRPFX, you might choose a mutual fund which is cash/bond based (such as RPSIX, Vanguard Wellesley or similar). I would then send that $507 each month to that mutual fund.

If one of these expenses happens- say you need a new roof- stop the $507 contribution and use that money (that month) to pay for the new roof. Obviously if you need 7k, that $507 gets directed to that expense over 14 months, or is used to replenish the EF if you draw down the cash. The purpose of the mutual fund is to be the "back up" which also can be used for larger things (like a dream vacation). It is also possible if you start this account early enough the interest it pays off funds the vacation or the new roof, and you might never need to touch the principal or sell a share. When you need a car you can make a decision- use the $507 to finance a car (this assumes the money invested returns higher than the interest rate on the car), or sell shares to pay cash for the car, then keep the $507 flowing into the investment.

Based on my calculations, we need to set aside around $900-1100/month in our house for our expected mid term expenses. My plan would be to finance the car for about 18 months ($16,000-$20,000 car) and keep the investment as a backup if the other mid term expenses happened in the 18 months of financing the car.

Here is my list:
Car $30,000 every 9 years=$278
Car $30,000 every 9 years=$278
Roof $5,000 every 15 years=$28
HVAC $3,000 every 10 years=$25
Hot water heater $1000 every 15 years=$6
Medical expenses $2400/year=$200
vacations $3600/year=$300
kids education $80,000 (one time expense in 18 years*2 kids; 40k each kid)=$370
total: $1385

**most vacations for us are much less, but that big one every few years throws that calculation off**
**medical expenses are now thru an HSA**

If the return of the mutual fund is less than the interest rate you are paying on the mortgage, it might make sense to alter this strategy. It is important to find an investment which has a positive return higher than what cash pays- because you are budgeting for some things which have inflation, yet the $29/month for the roof is not inflation adjusted, for example. Travel costs for large vacations would also be similar (you might budget $50/month for a vacation, but what $50/month gets you now and what it gets you in 5 years is two different things). Cash return (money market) would not be acceptable in this case (IMO).

If you look to my case, the $1300/month would go a LONG way to paying "cash" for kids education- meaning I set aside enough money to cover large expenses for those 4 years (make sure cars are in good shape) and then that $1300*12=$16000 of tuition payments as CASH with no tax implications of cashing out an investment.

[zetta]

You have no current plans for the money, but something *might* come up within 3-10 years that you would spend it on. How about some sort of bond fund? The advantage of buying a bond fund instead of individual bonds is that you have more liquidity, while taking on less risk than you find in stocks.

I'll admit that I haven't looked at the returns myself, and can't advise you whether the fund should be in long-term, short-term, or ultra-short term bonds.

(Just realized that Jim_Ohio was also recommending using a bond fund, but it was kind of buried in the rest of his calculations.)

[LivingAlmostLarge]

Wow Jim, your roof is cheap. Our estimate was $20-30k. Anyway I've found that 1% of our home value in repairs seem to crop up for me without even thinking about. There is always a project to be done.

And so the money ends up going to home repair, car repair, etc. I would also invest in a bond fund.

[jIM_Ohio]

Wow Jim, your roof is cheap. Our estimate was $20-30k. Anyway I've found that 1% of our home value in repairs seem to crop up for me without even thinking about. There is always a project to be done.

And so the money ends up going to home repair, car repair, etc. I would also invest in a bond fund.

My estimates were based on a post to a newsgroup similar to this, and most people had costs of 5k-10k.

I have 40 year dimensional shingles, the hope is that I don't need to replace the roof, just reshingle.