Let’s imagine for a second that tomorrow your washer machine breaks. Laundry is piling up, and your anxiety is building wondering how you are going to get caught up.
How do you plan on paying for a new washer machine? Do you dip into your emergency savings, or pull out your credit card?
The truth is, these types of expenses can be detrimental to your budget. You need to have a system in place that will allow you to pay for certain planned expenses with cash, so you are not continually going into debt.
That’s where sinking funds come in handy.
Today, we are going to cover everything there is to know about sinking funds, which funds I include in my budget, and how to use them.
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What Is the Purpose of a Sinking Fund?
A sinking fund is a set amount of money for a bill, or life event that you know is coming. A specific amount of money is aside every paycheque/payday in an envelope, cash box, or savings account and when it comes time to pay for that bill or life event, you already have the money set aside, ready and waiting. No stressing.
Having the money set aside for large bills or life events takes all the stress and anxiety out of those things for me.
A sinking fund is just a plan with a purpose to set aside a little bit of money for an expense you know is coming. Where an emergency fund is strictly for the little surprise’s life throws at you.
According to Dave Ramsey’s Every Dollar site, the definition of a sinking fund is:
“A sinking fund is merely a strategic way to save money by setting aside a little bit each month”.
And with researchers reporting that the average American saves just 3.8% of the income they bring home each month, we can confidently assume a lot of people aren’t aware of the magic of the sinking fund.
If a budget offers permission to spend, a sinking fund offers encouragement to spend—and to spend big”!
What Is a sinking fund used for?
So now that we have given a basic definition for what is a sinking fund, let’s talk about what sinking funds are used for.
In order to manage your money well, it’s really helpful to use individual savings accounts to make sure that you are savings for the things that you need to be.
Creating sinking funds will help you to get out of debt and to stay out of debt as you instead save up for and purchase or pay for the things that you need.
As soon as you have a fully funded emergency fund of at least 3 to 6 months’ worth of expenses, you should start setting up additional savings accounts for irregular or unanticipated (though not completely unexpected) expenses.
If your bank doesn’t allow you to easily set up multiple savings accounts, then I recommend setting up an account with another bank that does. Here’s some good recommendations from Nerdwallet.
Sinking fund v emergency fund
You might be asking, “How is a sinking fund different from your emergency fund?”
A sinking fund is designed to save for a specific expense. You know what you are saving for, how much you’ll put in it, and when you will need to use it.
An emergency fund is setting money aside for the unexpected. Your goal should be to have 3-6 months of expenses saved for all possible life emergencies.
Both of these saving strategies will make you feel more at ease when it comes time to needing the money, but they are created for very different reasons.
Which sinking funds should you have?
This isn’t a totally comprehensive list of every sinking fund you’ll ever need, that depends on your personal circumstances and what you need to be saving money for.
One person may need a podcast equipment sinking fund, someone else may have a kid’s birthday sinking fund.
You never know! So here are a few sinking funds that are pretty universal:
Having a car means throwing a lot of money at a big metal box that just gets you from one place to another. Fun stuff, right? Wrong.
But if you plan to own a car in your lifetime, it’s something you need to plan for. Having a car means that you’ll inevitably have to pay some kind of repairs because they break.
You can use your car fund for things like your yearly sticker, your license renewal, speeding tickets, new floor mats, any repairs, pretty much anything that is involved with owning a car.
We never want to think about our pets getting sick or passive away. If I even for a second think about my dog passing, I feel like crying instantly, seriously.
But animals aren’t invincible, and we need to plan for their injuries and illnesses as well.
Having a pet gets pretty expensive, so this emergency money can go to anything including yearly check-ups, medicine, new collars, leashes, dog food, and maybe even your pet’s birthday!
If you own a home, you’ll have to fix something soon. It may be something small, like a light bulk, but it could be something huge like a brand-new roof. You never really know what’s going to happen when you own a home and it’s always smart to be prepared.
Home repairs add up really quickly and it happens in the blink of an eye. Having that money in the bank can really change the way you treat your home, and a lot of the time you’ll pick more frugal, intelligent fixes.
If you’re anything like me, you’ve dropped a phone (or three) and cracked a screen. I once had a laptop literally overheat and smoking at home while working. This is proof that some of the most expensive things we own can just break at a moment’s notice.
Putting a $/£500 phone or a $/£1,500 laptop on a credit card seems like a good idea at the time but it can take you months to pay it all back. This is why a technology sinking fund is very important.
This sinking fund could replace your laptop, phone, headphones, security cameras, etc.
Travel funds can really take two forms, one fun, and one not-so-fun. Of course, you can set up a sinking fund for a yearly family vacation to enjoy.
However, the real sinking fund you should set up is a funeral/sickness sinking fund. I know, this is really depressing and morbid.
However, at any given time a family member could pass away or get really sick without you having any notice.
You may need to travel across the country (or even the world) to be able to be there for the funeral and be able to take care of your family.
Plane tickets are expensive and when it happens quickly you don’t have an opportunity to plan a cheaper ticket, so it’s really great to have a thousand or more dollars/pounds in the bank just to be prepared for these occurrences.
Christmas always seems to be really far away, until it isn’t. Every year after Christmas I find myself saying “next year, I’m going to start saving for Christmas before summer! I’m going to be so prepared” but it never happens.
Christmas never changes. It always comes.
Starting a sinking fund for Christmas presents is a great way to save yourself a ton of money in interest, as well as keeping your Christmas costs lower because you don’t over purchase as often when you use cash.
Then the list becomes more extensive if you are a college student like me where I might add funds like:
- hobby fund
- holiday/vacation fund
- insurance – life, car, home
- medical expenses, prescriptions etc
- annual subscriptions (i.e., Amazon Prime, Disney+, gym membership etc)
- taxes – property, self-employment
- new clothes for you and the family
- beauty – haircuts, waxing, nails, etc
- charitable giving
- big events – your wedding, your parents 50th anniversary, etc
Remember these are only suggestions. Just because I listed it does not mean you need to have it in your budget.
How much do I put in my sinking fund?
A good rule is to start planning six months out for an event, but if the item is a large dollar/pound amount consider nine months. This way you’re not trying to save for “everything” all at once.
As you look ahead at expenses, start giving them a dollar/pound amount and adding them into the tally. Since this is an ever-revolving account new money will flow in, and saved money will flow out. (i.e., birthday party expenses, braces, back to school clothes, school pictures, sports fees, summer camps, etc.).
A good tip is to go back through your previous bank/credit card statements and see what kind of one-off purchases there have been. Do you have enough of one type of purchase to necessitate its own category sinking fund?
Where should you keep your sinking fund?
Sinking funds can be kept anywhere as long as you can keep track of them.
Consider choosing a place where your money can be liquid and you can access it simply with ATM withdrawal, quick online transfer or by writing a cheque.
You may also want to keep your funds in an envelope set aside for a specific expense. The most important thing is that you know where it is and can access it when you need it.
If you decide to open a single bank account for all your sinking funds, you need to find means to separate the money for each expense when it’s time to spend.
You can keep a ledger, tracker or spreadsheet to keep track of the amount of money in each fund at every point.
You may also want to keep your funds in multiple accounts. It can be very helpful if your bank offers you multiple savings accounts, especially when you prefer doing all your transactions online.
Ensure that you meet minimum balances for each account if there is one.
However, options that allow you to access your money anytime can only work for you if you are disciplined with your savings account.
If you are not good at managing your savings account or you find yourself constantly transferring money in and out of your account, then you should consider an account that you cannot dip into when you please.
Keeping track of your sinking funds
It’s very easy to become distracted and lose track of your sinking funds.
Keeping track of your sinking funds is very crucial because you won’t want to forget, use your car maintenance and repairs fund for your friend’s birthday, and then start wondering about what happened to the money when the main expense comes up.
To keep track of all the funds, if you like to use paper and pen, you can keep a log. If you prefer spreadsheets, you can also use a spreadsheet.
You can also keep track of your funds with your bank’s app if your bank offers multiple savings accounts.
There are several ways to keep track of your savings. Choose one that works best for you.
Should you set up a sinking fund when you have debts?
Setting up a sinking fund when you have debts depends on what the fund is for. Your high-interest debt is an emergency, and you need to make efforts to pay it off.
However, some expenses are so very essential that you will need to come up with money from anywhere to pay for them—for instance, a new set of tires that you would be needing soon.
For such expenses, it’s best to set aside money since it’s better to pay for them in cash rather than use a payday loan or credit card.
If it’s for an avoidable expense like a vacation or holiday, then No. In such cases, you need to focus more on your debts instead.
Taking a vacation/holiday shouldn’t be a priority for you if you have a high-interest debt.
What is the purpose of a sinking fund? – final thought
Having a sinking fund is a vital part of your financial plan. It is as important as your emergency fund.
Setting up this particular fund will keep you from screwing up your monthly budget all the time and allow you to leave your emergency fund for real emergencies.
It might seem less urgent, but it is urgent.
You don’t have all the time you feel you have until that expense catches up with you.
The earlier you start saving for that major expense, the better.
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Hello! My name is Adam and welcome to my space on the internet. Here you can find me writing about topics such as lifestyle, self-care, self-development, finance, saving money and making money. Come and join the community!