Capital Fund The Credit Card Alternative

Nest Egg

The capital fund is your nest egg and emergency fund  ‐— the credit card alternative. It's savings for specific future buys and emergencies to relieve stress in the regular budget. The capital fund mimics depreciation, a business practice that provides for regular replacement of equipment. It is akin, too, to businesses' capital budgets. It needs patience and discipline and is essential to live a debt free lifestyle. But, the capital fund does not replace retirement savings.

The capital fund reflects the old Chinese proverb: dig a well before you are thirsty. Establishing the fund entails identifying likely future major expenses and then saving regularly to pay cash when needed. These emergencies will happen, but we don't know when.

Emergency Fund

Most people do not save to buy items such as cars, refrigerators, stoves, furniture, appliances, or for repairs or replacement of these objects. They spend as needed, using credit cards or lines of credit. They use funds from the household budget or they borrow. This erratic asset repair and replacement is stressful and expensive and a sure way to a long debt sentence.

The Credit Card Alternative

The capital fund is the credit card alternative because you buy stuff for cash saved in the fund for specific items — using your credit card and paying the full balance monthly counts as paying cash.

Simplistically, to replace an item costing $1000 with a ten-year life, corporations would set aside $100 yearly for ten years. At year ten, they replace the item and repeat the procedure. That's it! Imagine interest not incurred if you saved to pay cash for everything except a home

Individuals and couples I counsel, and who attend my seminars, testify repeatedly their capital fund had a major positive effect on their finances and stress levels. They said it was the single most important tool that contributed to their debt free life style.

Capital Fund & Children

Set aside at least 50% of funds you get for infants from government, grandparents, and other extended family members. As they grow older, teach them to give to charities and those in need, and save to pay cash for specific buys. Don't give them loans, encourage them always to save to buy what they need. Be an example to them. At a suitable age, which will vary for each child, develop with each child, the capital fund's purpose, such as saving to pay cash for:

  1. Education expenses — remove the need for student loans by saving a portion of government provided funds
  2. Engagement and wedding rings
  3. Down payment on a home
  4. A car, computer, and other items with a life span greater than two years

Debt Free Lifestyle Starts With an Emergency Fund

If you did not start a capital fund as a child, start when you repay all consumer debt. Do not wait to be debt free before you start the debt free lifestyle. Save to pay cash for:

  1. Down payment on home large enough to avoid mortgage insurance
  2. Car, including major maintenance
  3. Fridge, stove, furniture, major repairs on them and others
  4. Emergency expenses — three to six month's wages
  5. High insurance deductibles to lower insurance, but only if you understand implications

Why start a capital fund only after repaying all debts except your mortgage? Your capital fund will earn little income (maybe 3%) because you should keep it in a secure account; but, your consumer debts will bear high interest (maybe 25%) — the spread would be over 20 percentage points.

The temptation to neglect the capital fund will be great. Urgent but non-essential items you believe you must buy will arise. Don't give in to slick, seductive advertising or offers of cheap financing. Seek God's direction. Stay focused, and save monthly according to God's guidance.

Avoid the other temptation to invest the capital fund in stocks or bonds which are longer-term investments, not suitable for targeted savings. The state of the economy and stock market affect the value of stocks and bonds. Besides, you do not know when you may need to draw down your capital fund to repair the car, replace the stove, or other emergency. Remember, you may need to withdraw funds from your capital fund at short notice. So, keep these funds in an easily accessible account where the amount you deposit, will not be at risk. In Canada, the Tax Free Savings Account (TFSA) is the perfect vehicle for a capital fund.

Capital Fund Development

At your next salary raise or when you get extra funds, decide how much to put in the capital fund. And when you have the funds available, before spending, use the Affordability Index as a guide. If you don't use this procedure, ensure you follow a similar practice before spending.

Identify items to save for and fill in the form below to decide how much to save monthly. The amount to save should be your best estimate of today's price. So, $7,500 for the car would be your estimate of today's cost of the car you will buy in five years. A rough guide to decide if you should save for an item in your capital fund is the frequency of replacing or repairing the item. Save for items with life cycles over two years, or expenses that recur at least every two years. Remember, your goal is to keep these items out of your yearly budget. Each person must decide the minimum cost of each item he or she will include in this account.

Yearly Fund Review

Review your lifestyle and your capital fund yearly and adjust as needed. Change monthly contributions only after thorough evaluation:

  • Should you add or remove items?
  • Should you change the planned timing of future expenses?
  • Did you use realistic prices to calculate the spending amount?

These are two major challenges to start and continue a capital fund: First, how to get information and motivation to begin? The best you have is your earlier spending and future needs. Next, how to keep the discipline to set aside funds monthly? A trusted accountablity person will help.

Saving to buy a car for cash would involve these calculation:

  • Estimated cost today of a specific car = $7,500
  • How long before you replace the car = 5 years
  • Amount to save yearly - $7,500/5 = $1,500
  • Amount to save monthly - $1500/12 = $125