What Is a Replacement Fund and Why You Need One

Instead of taking out a loan to pay for a new roof or car why not make the payments in advance? You can do this by paying yourself into an investment account that will grow instead of costing you money… in other words you get the interest instead of the bank or your credit card company.

I know, for example, that our hose was built about 10 years ago and that the shingles on the roof are rated for 20 years. Replacing a roof is no small expenditure. For that matter replacing a hot water heater isn’t that cheap. These are just a few examples of expenditures that almost everyone is going to have to make sometime in the future.

Your Replacement Fund

Instead of incurring debt and fighting with your budget why not plan for these expenses and actually make them smaller by growing your money in advance of when you need to buy your new car, replace the hot water tank, paint the house, shampoo all the carpets or yes, put on a new roof?

A few steps will result in an efficient way to build your replacement:

  • Create a separate account with your broker, i.e. Fidelity Investments.
  • Make regular automatic monthly payments into the account.

How much you add each month can be figured easily by estimating the cost of the item and how many months from now you will need the money (cost รท months = dollars/month). You may need to add up all the different items to get your total monthly figure. If you don’t think you can afford the total don’t sweat it… start with what you can afford.

  • Use a few investment strategies.

Don’t put all your eggs in one basket. Have at least three strategies; perhaps one conservative and two moderate. While an aggressive strategy might be tempting since these investments are designated for specific purposes it is probably wise not to be overly risking.

The conservative strategy can be based on bonds, high-dividends (stocks, ETFs or funds) or a basic 3-5 conservative ETF strategy.

The moderate investments could use something like:

  • Sector ETFs
  • Fidelity Select funds
  • Large Cap funds, ETFs or stocks

An important factor with these strategies is to set them up with your investment software or adopt the mentality that they don’t require frequent trading and only need to be reviewed once a week for a few minutes or even less frequently.

Perhaps the biggest challenge in setting up a Replacement Fund is forcing yourself to cut a chunk of money out of your monthly spending budget. This is tough. But if you start out small and raise your investment amount every three or four months until you reach your goal the long term results will be more than worth it.

Simply ask yourself this question: would you rather pay yourself interest on your money or pay the bank? If you answer “yourself” it is time to start your Replacement Fund.

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