You may not quite get it and you keep asking the question, “What is a sinking fund?” Well, for instance, you know that you have to pay for major car repair at some point in the future
You may not know when, but you know that you’l need money for car maintenance and repairs. How do you intend to pay for this expense when it happens? Do you intend to use your credit card or pay it off with your emergency fund?
A sinking fund help you to set aside money for an unexpected expense in the future. It helps to keep you from blowing your budget when you didn’t plan for certain expense.
It also helps keep you thoughtful and proactive when it comes to spending and saving money.
You may be asking, “How is that different from an emergency fund?” A sinking fund is quite different from an emergency fund. Money that you put into an emergency fund is reserved just for emergencies or unexpected expenses, while money in a sinking fund is used for non-emergencies.
Money that’s set aside in an emergency fund saves you when there’s an unfortunate event or expense which you didn’t predict or expect, such as losing your job or a major medical catastrophe.
Taking money out of your emergency fund to pay for non-emergencies can create an actual sinking scenario when a real emergency occurs.
For instance, your car has some major problems, so you take some money out of your emergency fund to buy a new car, only to get hit by a medical emergency after your car purchase.
How do you intend to survive a financial situation like this?
Expected expenses like paying for insurance, making a property tax payment, buying a new car, going on vacations, buying birthday/holiday gifts, attending weddings, replacing your washing machine, dishwasher, water heater etc, etc. can easily be paid off when they arise if you set some money for them.
You don’t know when they’ll all come up, but you do know that they will come up at some point in the future.
A sinking fund is also different from a savings account. The two are very similar, but differ in one way.
You keep a sinking fund in a separate account specifically for an expense, while a savings account can hold funds for every purpose.
An example to help you understand how a sinking fund works is this. Let’s say that you have $800 to set aside in your savings account every month.
After one year, you will have a total amount of 9,600.
You may decide to replace one of your cars, so you go to the dealership and use the $9,600 that you saved up for your new car purchase.
What happens if your dishwasher breaks down, an unexpected medical bill arises or you have to buy a gift for your child’s birthday, your friend’s birthday and for your parent’s 40th anniversary just after you have purchased your car?
How do you manage a financial situation like that? Do you use your credit card and pay it off later or use part of your emergency fund?
This scenario is an actual sinking situation where you can find yourself scrounging for money to get through urgent expenses.
However, you don’t have to sink! A sinking fund can entirely change the narrative.
With the same $800 for savings set aside for sining funds every month, you can divide the $800 into four categories : $100 for medical bills, $200 for home maintenance and repairs, $400 for car repairs or for a new car, and $100 for gifts.
By the end of the year, you’ll have a total of $1,200 for your medical expenses, $2,400 for home maintenance and repairs, $4,800 for car repairs and maintenance or a new car purchase, and $1,200 to buy all the presents you want for your child’s birthday, your friend’s birthday, and your parent’s wedding anniversary.
This way, you’ll succeed in paying off your medical expenses, replace your dishwasher, buy gifts for your kids, parents and friends, and also be able to make some minor car repairs so that you can continue using it while you save up until your new car fund is enough to pay off the expense.
You may also decide to get another means f transportation that you can rely on for $4,800. So, now you see how everything is sorted without using a credit card or touching your emergency fund.
Why You Need to Set up a Sinking Fund
Now that you have the answer to the question, “What is a sinking fund?” you might want to know why you need one.
Irrespective of how well you make your budget, if you’re not taking into account known, irregular expenses, then you’ll be taken off guard when you’ll need to pay for these expenses.
You may end up using your credit card every time these expenses come up.
Review what you spend money on for a moment and you’ll notice a trend. There are certain expenses that you make every few months, every season of every year.
These can be home maintenance, car maintenance, vehicle registration, annual dues, vacations, birthdays, back-to-school expenses, sports fees, and holidays.
Oftentimes, these expenses are put on hold with the excuse that there is still time to save money for them; however, time usually runs out too quickly.
With a sinking fund, you will be able to save for these expenses and pay for them when they come up without having to take money from your emergency fund or use your credit card.
You’ll also get to enjoy guilt-free spending. When you have saved for a specific purpose, you won’t feel guilty about spending a large amount of money on that expense when it comes up.
You also get to determine the amount of fun you want to have. Starting early to save for that vacation, your child’s birthday, or Christmas means that you won’t have to cut your fun short because of your budget.
You get to have fun to the fullest without upsetting yourself over having no money in savings or debt.
Since you worked for it by saving up for that expense, you won’t feel guilty when it’s time to enjoy it.
Often, a big stress factor in our lives is the monthly payments of debts. Without those debts and the payments that go with them every month, our stress levels are bound to drastically reduce.
A sinking fund can help you avoid debt.
When you save for a particular expense, you’re basically paying for it in advance instead of paying after the purchase. And you won’t need to pay creditors or accumulate interest.
The opposite is the case here.
While you save with a high-interest rate account, you have a chance to earn accrued interest in your savings account while building up your sinking fund.
With a sinking fund, you can save for virtually anything that you want—the choice is entirely yours.
One good thing bout a sinking fund is that it keep you prepared. It’s just a matter of time before something breaks down and has to be repaired or replaced.
It sets your mind at ease knowing that you set some money aside for that expense.
How to Set Up Sinking Funds
Setting up sinking funds isn’t complicated, but it can be tricky. Here’s a step-by-step guide to help you set them up.
First, list everything that you want or need to set aside money for.
This list may be long, just list them all out. You probably have a couple of expenses that hould have sinking funds.
In case you’re having a hard time making a list of what you need to set money aside for, here are different categories that you can consider.
For home maintenance, these may be different home repairs, plumbing, roof, kitchen updates, HVAC, appliances, flooring repair, HOA dues.
For car maintenance, these may include tires, battery, brakes, alignments, windshield, engine, tuning belt, spark plugs, insurance deductibles in case of an accident, etc.
For birthdays, include kids, parents, siblings, friends, and your kids’ friends.
Kids’ school expenses—uniforms, supplies, crafts, field trips, and fundraisers.
Also, kids recreation and sports expenses like registration fees, uniforms, lessons, sports gear, sports camps, tournaments, sports travel and summer camps.
Consider holidays—Christmas / Hanukkah / Kwanzaa, Thanksgiving, Halloween, Easter / Passover, Valentine’s Day, the 4th of July, Memorial Day and Labor Day weekends.
Think of your yearly vacation, large vacation, and mini-vacation travel expenses.
Consider medical expenses that are not covered by your health insurance.
Pets—food, vet expenses, insurance premiums, and grooming.
The next thing that you should do is to pick the major ones or ones that are most important to you and your family. You need to be realistic when setting up your sinking funds. You can’t possibly set up your sinking funds for everything on your list, so you need to choose the ones to save for based on your priorities.
Decide how much you need to pay for these expenses and when you think you will need them. Again, you need to be realistic.
Find out the total amount that you need, then divide it by the number of months that you have until you need the money. What you’ll get is the amount that you should ave each month. For instance, if you have a $1,000 expense coming up in 10 month’s time, you’ll need to save $100 every month for ten months. Do the same for all the other expenses.
Create a section in your budget for each expense.
If necessary, open a separate bank account for your sinking fund.
Set up automatic transfers to your sinking fund account from your checking account every month.
Spend the money fro your sinking fund when you need it and start the process over again. Maybe you saved for a dishwasher last time. You probably won’t need to replace it soon, so you can start setting money aside for something else. It could be your refrigerator this time or that cruise you always wanted to take.
How Big Should Your Sinking Fund Be?
The size of your sinking fund depends on your total anticipated expenses.
Again, you need to be realistic when setting up this fund or you won’t have any money left for other savings goals, pay off debt or other short-term goal.
Don’t get carried away with creating sinking funds for too many things.
These umbrella categories that your sinking funds should cover are: large planned expenses which include a family vacation or a new car; unexpected expenses like replacing home appliances, a new roof or a broken furnace; and forgotten expenses which include clothes for growing kids, sports activities, school field trips or yearly subscriptions.
Where Should You Keep Your Sinking Fund?
Sinking funds can be kept anywhere just as long as you can keep track of them.
Consider choosing a place where your money can be liquid and you can simply access it with ATM withdrawal, quick online transfer or by writing a check.
You may also want to keep your funds in an envelope that you 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 open a single bank account for all of your sinking funds, you need to find means to separate the money for each expense when it’s time to spend it.
You can keep a spreadsheet, ledger, or tracker 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 multiple savings accounts, especially when you do all your transactions online.
Make sure that you meet the minimum balances for each account if there is one.
However, options that allow you easy access to your money will only work for you if you’re disciplined with your savings account.
If you’re not good at managing your savings account or you find yourself constantly transferring money in and out of your account, then you should consider a money market account.
A money market account can be better to save with since it’s slightly less accessible when compared to your checking and savings accounts.
Money market accounts also offer higher interest rates, and a layer of security in case you’re tempted to cash in the money before time.
Keeping Track of Your Sinking Funds
It’s quite easy to become distracted and lose track of your sinkig funds.
Keeping track of your sinking funds is crucial because you won’t want to forget, use your car maintenance and repairs fund for your friend’s birthday, and then wonder what happened to the money when the main expense comes up.
To keep track of all your funds, if you like to use paper and pen, you can keep a log. If you prefer using spreadsheets, you can also use a spreadsheet.
You can also keep track of the funds with your bank’s app if your bank offers multiple savings accounts.
There are a number of ways to keep track of your savings. Choose one that works bet 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 an effort to pay it off.
However, some expenses are so essential that you will need to cope up with the money from anywhere to pay for them. For instance, a new set of tires that you would be needing soon.
For these expenses, it’s best to set aside money since t’s better to pay for them in cash rather than use a loan or credit card.
If it’s for an affordable expense like a vacation or holiday, then No. In these cases, you need to focus more on your debts instead.
Taking a vacation shouldn’t be a priority for you if you have high-interest debt.
Having a sinking fund is an essential part of your financial plan. It’s just as important as your emergency fund.
Setting up his fund can keep you from screwing up your monthly budget all the time and allow you to leave your emergency fund for real emergencies.
It may seem less urgent, but it is urgent.
You really don’t have all the time that you feel you have until that expense catches up with you.
The earlier that you start saving for that major expense, the better.
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