Milestone 1: The Uh-Oh Fund
Milestone 1 is an Uh-Oh Fund and its primary purpose is to keep your financial head above water if small emergency expenses pop up as you focus on the next two milestones, taking advantage of your employer match and paying off toxic debt.
If you landed here without reading the previous article about the starting point of the Next Dollar Roadmap, Creating A Budget, I encourage you to go check it out.
Also, there are a total of ten stops on The Next Dollar Roadmap as listed below. Feel free to jump ahead if you feel that you are past any of the earlier milestones along the way.
- Starting Point: Creating Your First Budget
- Milestone 1: The Uh-Oh Fund
- Milestone 2: Take Advantage of Your Employer Match
- Milestone 3: Pay Off Toxic Debt
- Milestone 4: Fully Funded Emergency Fund
- Milestone 5: Save 15%-25% of Your Income in Tax-Advantaged Retirement Accounts
- Milestone 6: Save for Flexibility in Bridge Accounts
- Milestone 7: Prefund Kids’ Expenses
- Milestone 8: Pay Off Remaining Debt
- Milestone 9: Total Financial Independence
Why You Need an Uh-Oh Fund
As I mentioned before, the purpose of an Uh-Oh fund is to give you a small cash reserve that you can use to cover unexpected expenses, without having to make financially destructive decisions like taking on debt.
Think of it as a shock absorber for your cash flow. If you reach a section of rough road, you can absorb the bumps while continuing forward.
Life inevitably brings unexpected financial setbacks like car breakdowns, medical issues, and malfunctioning appliances.
Without some cash available to direct toward these needs you may be tempted or even forced to take on debt to handle them.
In that case, your small problem becomes a small problem with interest, further penalizing you for what was already an unwanted situation.
It’s a model example of adding insult to injury.
An Uh-Oh Example: Penniless Pat & One Grand Grant
Penniless Pat & One Grand Grant are basically identical. In addition to having odd names, they have the same monthly after-tax income of $3,500.
They spend the same amounts on rent, groceries, fuel, etc. so that after all their monthly expenses are paid, they each have $500 remaining for either saving or spending.
Penniless Pat is really into music, so he spends his extra $500/month on concert tickets and streaming services.
One Grand Grant loves music too, but he decides to sit out the concerts and listen to Pandora at home for free.
As a result, Grant’s been using his $500/month to build up his Uh-Oh fund and start contributing to his company’s 401k plan to take advantage of the employer match.
Wouldn’t you know it? The air conditioners at both Pat’s and Grant’s homes go out at the same time. Shockingly enough, they have the same problem and the same costly $1,000 repair.
One Grand Grant pays cash to repair his air conditioner and uses the next two months to resupply his Uh-Oh fund.
On the other hand, Penniless Pat doesn’t have any cash left since he went to that sick Nathaniel Rateliff concert last week.
While Pat’s taste in music is impeccable, his financial decisions have left him in a tight spot.
Fortunately, the A/C repair guy offers to put the repair on credit with an annual interest rate of 12%.
Pat tightens up next month and pays back $500 of the $1,000 balance, leaving him with $510 of debt.
But shouldn’t Pat only owe $500 now? Unfortunately, that’s not how credit works.
So why does Pat owe $510?
Because Pat borrowed $1,000 last month which, at a 12% annual interest rate, incurred $10 in interest. ($1,000 x 12%/12months = $10)
So next month Pat owes $510, right?
Not quite.
Pat now owes $515.10 because the $510 he owed from the 2nd month has incurred another $5.10 in interest.
Thankfully, Pat decides to forego Starbucks one morning and direct the latte money toward his debt and have it gone for good.
Final total for Grant = $1,000
Final total for Pat = $1,015.10
Now you may be tempted to look at this and point out that $15.10 isn’t that much money.
I have to agree, but what if a few of the variables changed? What if the repair was more expensive and took longer to repay?
What if Pat’s A/C repairman didn’t extend credit and Pat had to use his Visa which has an even higher interest rate?
In 2024, credit card companies charge an average interest rate of 24.92%, and the highest cards out there charge 36%!
Imagine stacking up a few repairs on THAT card. Ouch!
And if our friend Pat is normal, in all likelihood he’s carrying a credit card balance each month.
After all, in 2024, the average single American carries $3,336 in credit card debt.
The average household credit card debt in 2024? $8,674!!!
Running through the math, this means the average credit debt-carrying American household is incurring $180.13 in interest charges each month ($8,674 x 24.92%/12 = $180.13).
Our friend Pat is going to need to do more than drop his Spotify subscription to pay that down.
This is why it’s so important to keep an eye on your debts. Factors like outstanding balances and interest rates can make you a slave to them.
And this is why you need an Uh-oh fund. You have to be ready to handle disruptions to your financial progress without turning to debt for help.
How Big Should My Uh-Oh Fund Be?
I recommend having at least $1,000 in your Uh-oh fund.
This should cover most annoying repairs or emergency expenses for a single adult.
If you have a family, then I would increase this amount up to the value of your highest insurance deductible.
For example, if your homeowner’s deductible is $2,000, your medical insurance deductible is $2,500, and your auto insurance deductible is $700, you should save $2,500 in your Uh-Oh fund to cover your medical insurance deductible since it’s the highest of the three.
By having this cash available in your Uh-Oh Fund, you can turn your attention to the next steps on the Next Dollar Roadmap which will both serve to quickly improve your net worth.
Eventually, we will be building a much more robust cash reserve, but I wouldn’t focus on that until you’ve eliminated high-interest debt and taken advantage of your employer’s generosity by investing up to any matching contributions they are willing to make to your employer-sponsored retirement plan.
The interest on your debt or the contributions you can obtain from your employer is likely to be more valuable in the long run than filling up on cash first.
Next Stop: Milestone 2: Taking Advantage of Your Employer Match
