Beginner’s Guide to Sinking Funds
Sometimes we need money really quickly, a lot of the time it’s for an emergency that we didn’t know was coming. This can be totally solved by using an emergency fund but sometimes these expenses are totally foreseeable. This is where sinking funds come into play! Understanding a sinking fund is key to being prepared for expenses in advance! I know you’re busy, so if you can’t finish this whole post now you can pin it for later!
So, what exactly is a sinking fund?
Think of a sinking fund as a pot of gold at the end of a rainbow. It’s one of the best ways you can avoid accumulating credit card debt when your car breaks down, or you go on vacation. A sinking fund is essentially a nice pile of money that you choose to collect with a specific purpose in mind, you use this money for one thing and one thing only.
Sinking funds are the best way to save for a specific event that you know you’re going to have every year (i.e., property taxes) or that will eventually happen (i.e., car repairs).
So, let’s say you put away $100 a month because your average car repair costs in a year are a little over $1000. This means that you have the cash to be able to pay for your car repairs when they do happen and you don’t have to pay interest you get to earn interest on this money. Sounds pretty good right? Too good to be true? It’s totally doable.
So, how do we set up a sinking fund?
The first thing to figure out when you decide to start using sinking funds is where you want to keep that money. You need to make sure that this money is easily available to you (or liquid, in financial terms). This means that you’ll have easy access to the money, without incurring any penalties for taking it out too early.
The only place you shouldn’t leave a sinking fund is in high-risk investments where you could lose all the money because this money has a purpose and you shouldn’t let it slip through your fingers! If it’s an event that could happen anytime (like a car repair) you should keep that money in a savings account because you won’t have to wait long to get access to it.
The only thing you need other than a savings account to set up sinking funds is a good budget! If you’ve never set up a budget before, or have never had one stick, you should definitely look into the zero-based budgeting method. It’s the best way to make a plan for every penny and really make the most of your money.
You can add a sinking fund to your budget by simply adding another line item to your monthly budget and having a little less fun money each month (trust me, it’ll be worth it).
Why are sinking funds a good idea?
Most of us spend a lot of our time reacting to things. We react to other people, we react to the weather, we react to notifications on our phone, but the one time we don’t want to be reactive is when we’re thinking about our finances! When we need money quickly we often take a reactive path, rather than a proactive one. We’ll reach for our credit card and think about the repercussions later.
Sinking funds allow us to be proactive, we plan for the future and don’t just let things happen to us. Being proactive is one of the biggest qualities of highly successful people and adopting this way of life is a great way to become more financially successful.
Which sinking funds should you start with?
Car Repair Fund
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, parking/speeding tickets, new floor mats, pretty much anything that is involved in owning a car.
Pet Veterinary Fund
We never want to think about our pets getting sick or passing away. If I even think for a second about my puppy passing I start crying, seriously. But animals don’t live forever and it’s something that we need to plan for.
Even if it’s just being prepared for their yearly check-ups and any medicine they may unexpectedly need, it’s always a good idea to be prepared. You could also add a little cushion in here for other pet supplies you may need. Maybe you buy your pet food in bulk and every month you can put some money aside for it. Or for your pets birthday (yes, I throw my dog a birthday party). There are plenty of pet expenses that could come up!
Home Repair Fund
If you own your home, you’ll have to fix something soon. It may be something small, like a light bulb, but it could be something huge like a new roof. You never really know what’s going to happen but it’s always smart to be prepared.
Home repairs can seriously add up and it happens fast. Having the money in the bank can really change the way you see them and will make you pick more frugal fixes because it isn’t plastic money, it’s real money!
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 start melting in the middle of a college semester. Although we don’t like to think about it, our technology breaks. Some of the most expensive things we own can just break at a moments 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. Even if you just have $500 for emergencies if something breaks to pay for repairs, it can save you a ton of money in interest and also save you money on your phone bill by not having to have a more expensive contract.
As someone who works from home, a laptop fund is a serious necessity. If my computer breaks I literally can not do my job and make more money!
Kids are expensive. This isn’t a sinking fund I’ve had to ever set up because I don’t have any kids. However, I have a little sister and I’ve experienced all the small costs that add up to take care of those little nuggets.
It seems like every single day my sister comes home with some form from school where she needs $5, $10, even $50 for some kind of something. Having money set aside for these expenses can be key! You never know when a friend is going to have a birthday, or when your son or daughter is going to rip their backpack and need a new one tomorrow. Staying on budget is hard when your kids are constantly throwing a wrench in your plans, but having money set aside can really change how you view your kids money stuff!
Travel funds can really take two forms, one fun, and one not-so-fun. Of course, you can have a sinking fund set up to save money for a family trip to Disney or to visit your parents at the cottage next summer. However, the real sinking fund you should set up is a funeral/sickness fund for travel.
At any time a family member could pass away without you having any notice and you may have to travel halfway across the country (or even the world) to be able to be there for the funeral and to take care of your family. You never know how much money plane tickets could cost until you’re buying them two days before you fly while you’re also grieving.
This fund can also be used if your family member gets sick and you need to travel home to take care of them. To really get the most out of it, you can use your emergency fund to help cover expenses during this time as well.
Christmas always seems to be so 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. It’s never going to sneak up on you.
Starting a sinking fund for Christmas presents is a great way to save yourself hundreds of dollars in interest, as well as make better purchases because you’re less likely to over purchase when you’re using cash.
How much money should I put in my sinking funds each month?
How much money you put away each month depends entirely on when the event could occur. If you’re planning for something that only happens once a year, you can put away less each month. If it’s something that might happen tomorrow, you may want to increase this buffer quicker just to be safe.
The nice thing about sinking funds is once they hit a certain amount of money without you touching it, you can stop funding them entirely. For example, if you need $2,000 in your technology fund to be prepared if your podcasting equipment happens to break tomorrow and you hit that $2,000 mark, you can start using that $100 a month on something else!
Can we see an example of a sinking fund?
Let’s do a quick example of exactly how sinking funds work in a real-life situation we all face.
Let’s say that Catherine is a mother of two young kids and is planning for next years Christmas. Her kids are still under 5 so she decides that she wants to spend $250 on each of them as well as $500 on all other gifts (for her husband, her parents, her siblings, etc). This means she needs a total of $1000 by December 25. If she starts working towards this goal on January 1st, she’ll have 12 months to save this money. To know how much she needs each month, she’ll easily divide 1000/12 and find out that she needs 83.33333 or $84 a month.
If you think of events like Christmas in this way, it makes it seem so much less stressful and you’ll be able to have so much more freedom when Christmas comes around because you won’t have to be worrying about money.
Sinking funds can really change how you think about your finances and how you handle your money. You can start with just one or two sinking funds that are always hard for you to budget for, and work from there. I promise, it can change everything.
If you use any creative sinking funds, let me know in the comments because I’d love to add some new ones to my finances!