Have you asked yourself what are sinking funds?
Birthdays, holidays, and that trip to Hawaii are all coming…fast. These aren’t surprises so what are you going to do to prepare for them? That answer is a sinking fund. A sinking fund? What is a sinking fund? You may ask.
Chances are you have already had one sinking fund or another without even knowing you did. Some of you may have established sinking funds even as early as childhood. Remember that old Coca-Cola bottle piggy bank that you kept money in for something you wanted so badly?
That was your sinking fund!
Historically, sinking funds were used by governments or large corporations to gradually prepare for payment of an expected debt. In everyday use, a sinking fund is an intentional fund set aside for a specific, normally large, purchase.
It’s as simple as that. Sinking funds are used to save in advance for the expected. Here’s all you need to know about them.
Who needs a sinking fund?
Everyone! Sinking funds are something that can benefit us all. The average American normally saves less than 10 percent of their income after paying taxes and covering expenses. Sinking funds make it possible to factor in those expected expenses in advance giving you a better opportunity to plan and save.
Sinking funds give you the ability to keep yourself from “stealing” from other budget lines or even worse going into (or further into) debt. These funds are an excellent solution for anyone looking to make a big purchase.
Considering the fact that the majority of us have some big item or expense that comes up annually, sinking funds can cover virtually anyone. Sinking funds allow you to keep your financial goals in focus.
What types of purchases can be made with sinking funds?
Sinking funds can be limitless but here are some of the main areas to use them:
- Annual Membership Fees or Dues
- Planned Medical/Dental Procedures
- New Instruments/Tools
- Crafts/Hobby Supplies
- Clothing, supplies
- New/Used Car Purchase
- Home Renovations
- New appliances, new furniture, etc.
- Gifts – birthdays, Christmas, weddings, etc.
- Decorations – birthdays, Christmas, etc.
How do you establish a sinking fund?
A sinking fund is established first by determining what your financial needs are for your purchase. In other words, how much will this cost you? Take that amount and divide it by the weeks or months you have left in order to make your purchase at the desired date.
For example, if I want to save $2,000 for Christmas and we are currently in the month of May. That gives me about 6 months (or 24 weeks) to prepare. I would then divide $2000 by 6 months (or 24 weeks).
So, that means I will need to budget to save about $333 per month (or $83 per week). That is to say, by the time Christmas arrives I will have $2000 to spend however I want…guilt-free. Why, you asked? Because I budgeted for it, just for this purpose!
If the amount is unknown, do your best to guess. It is better to overestimate here in order to be fully prepared for the expense. Any funds left in excess can be used to pay off debt, save, or invest.
In addition, a great way to save some extra money for your sinking fund is by automating your savings. Trim is a savings app that analyzes your spending patterns to find ways to save you money on your cable and telephone bills and unwanted subscriptions.
Where do you store sinking funds?
The best way to “accident- proof” your sinking fund is to store it in an entirely different place than your regular savings account. Therefore, it's clear which funds are directly related to the sinking fund and most importantly in order to keep up with tracking your funds’ progress.
Certainly, establishing a completely separate account works in this case. You can even give the account a title, such as “Christmas Fund.” If you really want to take it up a notch, you can store your sinking fund in a completely different bank or credit union!
Although we do not recommend using cash, another alternative would be the cash envelope system. Sinking funds can be kept in separate envelopes with the title of each fund for clarity.
Keeping your sinking fund as liquid as possible is key. Storing your funds in a Certificate of Deposit (CD) or in stock market won't be the most ideal, especially for funds to be used > 1 year.
CDs normally have longer waiting periods and investing in the market may lead to short term losses that may devastate your plans for your funds. Storing them in a high yield money market with checking book and/or debit card access will suit you just fine.
We prefer Ally bank for our sinking fund. Ally provides clear, comprehensive “buckets” where you can choose to allocate money to fund each of your sinking funds.
This, by far, is the easiest way for us to manage our sinking funds. We have the cash right there at our finger tips and enjoy the freedom of checking on our sinking fund and our regular savings/checking accounts all at the same time.
Whichever route you choose make sure it's easy for you to access, track and fund.
How do you keep track of your sinking funds?
There are several ways to keep track of your sinking fund. Your best tracking method will go hand-in-hand with where you normally keep track of your budget and where you store your sinking fund.
If you are a pen and paper budgeter you will need to keep track of your expected money contributions along with your progress from previous months (or weeks). If you are using a spreadsheet or an application you may have the ability to have most of the recommended additions calculated for you.
Either method you should be able to refer to your bank account (or envelope) to ensure that the correct funds are present every time.
The Everydollar App makes it pretty simple to add and keep track of your sinking fund. Under the “Savings” Section click “Add Item.” This will allow you to label your desired fund. After labeling your fund click “Make this a fund.”
You will then be presented with options that allow you to enter your desired amount and your monthly contributions. There is even a place to indicate how much money you may have spent in the fund. We will not need to worry about that section until we have arrived at our desired date.
What are sinking funds what is it not
Sinking funds, up until this point, may have sounded a lot like emergency funds or even savings accounts. Here are some clarifying points on what sinking funds are and are not.
Sinking funds are not a savings account
Sinking funds and savings accounts are both places to store money for a purpose but there is a difference. Your sinking fund is a place to store money for a defined amount of time for a defined purpose. You decide the purpose and you decide the time frame.
On the other hand, a savings account is one of the tools you will use to build wealth and save for the indefinite future. That is to say, both accounts are useful for keeping your money secure. Ultimately, the main difference is time and purpose.
It's important to understand the difference of the two.
Sinking funds are not clutch funds
Whereas the differences between a savings account and a sinking fund were a little murky, the differences between a sinking fund and your clutch (emergency) fund are quite clear. Your emergency fund is designed for just that, emergencies. Emergencies are normally urgent events that are unexpected.
You may not have anticipated your dog swallowing that stick on your evening walk leading you to the vet at 2 am. However, you were fully aware of that trip you were going to take to the Bahamas. You see the difference there? Sinking funds are designed to give you peace of mind for your expected expenses. Guilt-free, peace of mind.
Sinking funds are guilt-free
If you saved $500 for your 30th birthday celebration then you better spend five hundred dollars on whatever you’d like. Sinking funds are funds that you have worked hard to build. You have created them for a purpose and once your mission is accomplished you deserve to spend it as you please.
Spend the entire thing! If, for whatever reason, you have overestimated your needs then by all means use the excess to cover an area that you see a need. You now have given yourself the control to spend as you please and you have shown yourself that you have the discipline to save any amount you set your mind to.
Congratulations, you are now a sinking fund pro.
Do you use a sinking fund? What type of sinking funds do you have?
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