Budget for Big Expenses With a Sinking Fund
In a nutshell, this is what a sinking fund is but there is so much more you should know.
Culturally, I think the idea of a sinking fund has been lost in the United States. We want instant gratification. The patience to save up for a new car over a few years is hard to find. It is also so easy to finance items now! Nowadays, we can even finance buying simple items such as a new shirt from Lululemon with Afterpay or Klarna. Having easy access to financing options only reinforces the habits of impatience we have developed.
People not using a sinking fund is something I have observed over the last couple of years.
We have actually started doing the opposite. We take out a loan to pay for the item first. As a cost for instant gratification, we pay interest on that loan. To save us money, we should be saving up first, maybe even earning some interest on that savings, then purchasing the item.
What is a Sinking Fund?
As I have hinted, a sinking fund is a special savings account you set up to save up for a large purchase. We will talk about what the fund can be used for later.
The term “sinking fund” comes from the business world.
“A sinking fund is a fund containing money set aside or saved to pay off a debt or bond. A company that issues debt will need to pay that debt off in the future, and the sinking fund helps to soften the hardship of a large outlay of revenue. A sinking fund is established so the company can contribute to the fund in the years leading up to the bond’s maturity.” (Investopedia)
Difference Between a Sinking Fund and an Emergency Fund
There is one big difference between a sinking fund and an emergency fund.
As we have already learned, a sinking fund is used to help save up for a big purchase. An emergency fund can also be used for large purchases. The main difference between the two is one fund is used for planned purchases (sinking fund) and the other is used for unplanned purchases (emergency fund).
I do not want to go too deep into emergency funds because we have an article about them already. In this article, we learn they are for those unplanned expenses that life can throw at you. Some expenses that an emergency fund can be used for include:
- Broken Appliance
- Car Repairs
- Job Loss
Sinking funds on the other hand are intended to help you save up for large one-time expenses.
Types of Sinking Funds
Some types of large one-time sinking funds include:
- New appliances
- Home Repair
- Home Renovation
- New car
- Medical Expenses (Human or Pet)
- Vacations
They can also be used for larger recurring expenses. My wife and I use our normal checking account for these expenses. We tend to keep a solid five-digit balance within our checking account on top of our emergency and sinking funds just for these recurring expenses.
- Car Insurance
- Car Registration Renewal
- Christmas/Birthday Gifts
- Summer Camp
- Back-to-school shopping
- Annual Subscriptions (software, streaming, etc)
Best Ways to Save for One
Starting to save for a sinking fund really is not too hard. First, you start with a dollar amount for what you want to save up for such as a $5,000 vacation. Then you figure out how long you have to save up for that vacation. Let us say 10 months for this example. We can figure out how much we need to save monthly by dividing $5,000 by 10 months. In our example, we will need to save $500 every month.
Once you know this monthly amount, you need to figure out how this will fit into your monthly budget. Our vacation sinking fund is the third in line for priority. First, we need to contribute to retirement, then our emergency fund needs to be full ($15,000 in our case), then we fulfill our monthly amount for our sinking fund. The remaining amount goes into our checking account to make sure that it is filled enough for those recurring expenses.
Lastly, you should be putting your funds into an account that will earn you interest while you save. This account can be a high-yield checking account or even a money market account. We personally keep ours in a conservative fund within Betterment. I like this option because we can set up an auto-deposit into the fund. It takes the effort to save out of the equation.
5 Tips for Success With a Sinking Fund
1. Separate
Keep your sinking fund money separate from the rest of your money. This gives that money a focused purpose. It is easy to get distracted from your goals. If your funds were in with your general pool, it would be easy to tap into it.
2. Name
Naming your fund will also help you stay focused. You can name your fund “New Furnance” or “Disney Vacation”. A name helps remind you what you are saving for.
3. Automate
When possible, automate the deposits into your fund. This helps make sure a deposit is not missed so you stay on track with your saving goal. Auto-deposit also helps eliminate the opportunity to make an excuse to not deposit this month because you want to purchase something else.
4. Windfalls
If it makes sense, deposit any extra money you might earn such as from a bonus or tax refund. This will help accelerate the saving process and get you to your goal sooner.
5. Prioritize
Some sinking funds will have a higher priority than others. Be sure to focus on those first compared to ones that might be a “want” rather than a “need”.
Conclusion
A sinking fund is a powerful but simple finance tool that can help you save up for large one-time or recurring expenses. They help you purchase items such as cars or vacations so you do not have to take on more debt.
This article is not to knock you, the reader. I am not perfect either. My wife and I financed a new vehicle we bought this past summer. We did a cost-benefit analysis and waited for a deal on the financing, 1% APR. The moral of this short story, financing sometimes does make sense. I am not here to make you feel bad if you make a well-thought-out decision to finance something.
While they take a lot of patience and focus, sinking funds can help you keep your finances in better health instead of just financing to purchase items.
If you are looking to earn more income to help you save up your sinking fund then we have a page for you! Over the years, Andrew and I have slowly been putting together a massive list of Ways to Earn Money. Check it out! You might find something you love!
Wallet Squirrel is a personal finance blog by best friends Andrew & Adam on how money works, building side-hustles, and the benefits of cleverly investing the profits. Featured on MSN Money, AOL Finance, and more!
My parents actually put money in envelopes labeled “car” or “television” and when they had enough they bought the car or television with cash. I grew up knowing I would never have to have a car payment or a balance on a credit card and I never have. Once we got the house paid off early we never borrowed money again. But to do it you have to save up enough to pay cash and sinking funds are a great way to do that.
The best time to plant a tree is 20 years ago. The second best time to plant a tree is today. I’d say the same thing can be said for a sinking fund. Automating really helps since I can pretend the money doesn’t exist until I need it.
I love all of this Allana! I couldn’t agree more!