Building a Reserve for a Primary Residence?

Question

This might be a dumb question, but the thought occurred to me the other day... obviously when investing in a rental property you factor in expenses like CapEx, Repairs, Vacancy, Prop Management and others. Being someone who has always compartmentalize my finances I was wondering if it was smart to pretend I was my own renter and pay myself monthly into a reserve, mainly the CapEx and Repairs percentage that I would apply to an investment property. That way when the time came to spend money on my PR I would hopefully have most, if not all, of the funds already set aside.

I'll mention, my wife and I plan to live in our home for the next 8-10 years and start our family here. There aren't any major things on the house that will need attention, at least in the next ~5 years. I'll also mention my financial planning thus far has set me down the path of having an emergency fund (~6 months expenses), vehicle repair fund, vacation fund and even general savings fund, all of which a portion of my biweekly paychecks direct deposit into.

This probably all comes down to personal preference but I guess my main question is this. Does it make sense to set aside cash monthly into all of these different savings funds, including a PR reserve, to account for future expenses, or is that capital better used elsewhere?

I guess I'm just looking to learn of other people's strategies for financial planning.

JD Gunter · Answer

I had never heard of cost segregation until my accountant recommended it to me and I hired a firm to do it, now I've done several. I'm not aware of any books or resources on the topic, but I have been contacted by segregation analysis people here on BP. Maybe you could do a search and reach out to them.

Kyle Josefiak · Answer

Thanks a lot JD! This was super helpful!

Do you happen to have one or two favorite resources for learning more about cost segregation analysis? Would love to learn more and try to apply it to my personal home like you said.

And you hit my question right on with the "opportunity risk" holding too much cash. That's pretty much exactly what I was thinking about when I questioned having too many different buckets of cash that I slowly add to. I think your recommendation for an all encompassing 6-8 month emergency fund for everything, including the one or two potential unforeseen large home repairs.

Really appreciate the feedback!

JD Gunter · Answer

That's actually a pretty insightful question.

In commercial real estate, we do something called a cost segregation analysis that projects the life of different structural and mechanical elements of a building for the purpose of tax depreciation. That being said, I've referred to it on my commercial properties as a method of anticipating expenses.

For your personal home, you could do a version of this with the intent of anticipating expenses. It would almost certainly be overkill to have a cost segregation done, but the exercise could be helpful and might be a good educational experience for understanding how properties break down.

As far as your personal finances, unless there is something specific you are anticipating such as a hot water heater, furnace, or roof, you are probably okay just having the 6-8 months emergency fund. Once you have that, you'll likely have enough cushion and can put your other funds into investments. There is an "opportunity risk" that comes from holding too much cash and not utilizing it to its full potential.

I hope this helps!