Sinking Funds are Like Life Jackets for Your Finances
I’m so excited to dedicate an entire post to one of my favorite personal finance hacks – Sinking funds!
According to a survey conducted by Bankrate in 2022, less than half of adults would pay for a significant expense with their savings — a quarter would pay with a credit card instead. Their study asked, “How would you pay for a surprise expense?” Meaning, If hit with a $1,000 emergency room visit or car repair expense, you would….. Pay with a credit card? Use savings? Ask to borrow money? Or get a personal loan or another option?
Instead of using savings, 25 percent of people would pay for an unexpected $1,000 expense using a credit card while paying it off over time — the most significant percentage saying they would use a credit card in the history of Bankrate’s survey since 2014.
What is a sinking fund?
A sinking fund is a strategic way to save money for a specific purchase by setting aside a little bit each month. Think of sinking funds as small savings buckets for large purchases, known but irregular expenses, or one-off events.
Sinking funds work like this: You’ll set money aside every month in one or multiple categories for later use. That way, you’re saving up small amounts over a longer time frame instead of having to come up with a big chunk of money all at once. Think of sinking funds as eating an elephant one bite at a time!
Some examples of sinking funds might include:
- Property taxes
- Vacation
- Car repairs
- Tax prep
- Clothing
Sinking Funds vs. Emergency Funds
Sinking funds differ from emergency funds because they are for specific goals, while an emergency fund is money set aside for the unknown. You know the items in your sinking fund categories are GOING to happen, but you may not know when. Your goal is to not have a one-off event or an event you didn’t properly prepare for SINK your budget.
Additionally, an emergency fund is for emergencies! Most of the items we consider emergencies aren’t true emergencies. They could have been covered by a sinking fund.
Why use sinking funds?
1. Ditch guilt associated with large purchases. Wanna give your children a blowout Christmas to the tune of $3000? Start in January, and that’s only $250/month.
2. Prepare for expenses like tax prep (we paid $1350 this year between all our businesses!!) and back-to-school shopping. A sinking fund makes the process stress-free!
3. Plan for future fun! Funding Disney or a credit card is only fun until you have to pay it off!
4. Give yourself a budget for out-of-control categories. If there’s only $400 back to school, then there’s only $400.
5. Turns irregular expenses into a standard monthly bill. Monthly expenses are familiar and easier to control that big hairy surprise expenses.
How to include Sinking Funds in Your Budget
I’ll give you 2 different ways to incorporate sinking funds into your budget, but let me give you a word of caution. There is such a thing as too many when it comes to sinking funds. If you determine you have $600/month to dedicate to sinking funds, splitting it into TOO many categories may be less effective in meeting your goals. It would be best if you still prioritized your goals.
One-off event
- Your best friend’s destination wedding is next June.
- Hotel, new outfit, car rental, food – $2000. It’s March, so you have 16 months to prepare, which is $125 monthly. Once the event is over, you will no longer save the $125/month.
Known irregular expense
- Known irregular expense – 6-month car insurance premium – $700
- If you pay this bill every six months, you will divide $700 by 6 months, that’s approximately $116. This example differs from the above, but you will save this amount indefinitely because you’ll always need car insurance.
Where do you keep sinking funds?
You can keep your sinking funds in the following:
- Cash – I would only do this for categories that you need ready cash for, like clothing, AND only if you trust yourself not to spend the money.
- All in one place – You can keep all your sinking fund money in one savings account and digitally separate your balance into categories using an app like YNAB or EveryDollar. This means your balance maybe be $2000, but you have a record of how much belongs in each category on your app.
- Separate savings accounts, which is what I do. I recommend Ally.com or Capital One 360 to my coaching clients because you can have unlimited free online savings accounts.
Conclusion
Whether you’re new to budgeting or you’ve been at it for a while. Sinking funds can be a great way to help you keep your budget afloat. By setting aside a little each month, you can create a safety need to keep small or large expenses from derailing your financial progress. Sinking funds can also give you peace of mind that when expenses known and unknown come, you’ll always be prepared. If you need a way to keep track of your sinking funds, download my free sinking fund worksheet here.