The word “sinking” can be a little intimidating when you associate it with your money, but in reality, a sinking fund can be a way to help you better prepare and project how to spend your money.
So, what is a sinking a fund?
Simply put, a sinking fund is a way to allocate the money you are saving, with a specific purpose in mind. Now some of you are maybe thinking to yourself, isn’t that called a savings account? Yes, but remember the part about “with a specific purpose in mind”. Sometimes to pay off a one-time thing. A sinking fund is a great way to plan for a future expense(s) that we know are coming down the pike.
What are some ways I will use a sinking fund?
Sinking funds are broken down into three main mind sets of how they are used:
Big Purchases:
Thinking of purchasing a new car? How about upgrading your cell phone? I know, you’re finally putting in that backyard pool you’ve been dreaming about. All of these can be huge hits to your bank accounts, but planning and knowing this is something you will be purchasing in the coming months to year, you can help put large amounts aside, specifically for those items.
Large Bills/Expenses:
Do you have an Amazon Prime membership? What about your car insurance, do you pay that as quarterly or yearly payments? Streaming services are huge now too, meaning Netflix or Hulu, any of these something you buy a yearlong subscription of? Think of items that you pay in a one big, lump payment once or twice a year. If you put money aside for them each month for this one large year end payment, wouldn’t it be nicer to know the money is already allotted for, vs. adjusting that month’s budget to fit that large expense?
Upcoming Events:
This category can cover things in a wide variety. You know Christmas falls every December 25th, so why not start putting money into the sinking fund today, so as you buy gifts, your eyes don’t glaze over every time you see your bank account decrease. You can also create a sinking fund for a nice relaxing vacation. Want a cabana by the pool while you’re there, or can’t wait to do an excursion? Budget that into your monthly savings so you can enjoy all the little extras on vacation guilt free. Or you can think even bigger…. like a wedding! You’re going to be getting quotes and prices ahead of time from all of your different vendors, so you’ll know the majority of your final costs will be when the day comes to pay your final deposits. Rather than dreading those days they are due, be proactive and slowly start stock piling that cash for your dream day.
How do I start saving for a sinking fund?
There are a couple of ways you can go about creating sinking funds, it’s a matter of how detailed you want to be.
Some people put everything in their savings accounts, but as they create their monthly budgets, detail out how much is going into the account with specific line items. You have to keep very good paper records with this method as you will have just one large lump sum in your account, with no way to differentiate what dollars go where, besides your own personal key.
Others will use the envelope trick. They will put that specific monthly amount of cash allotted for that item in a specific envelope labeled with what it is they are saving for, so when they time comes, they just pull the money directly from the envelope to make their payments.
If your sinking fund is for a longer-term purchase, we typically recommend you allocate those dollars into a Schwab Brokerage Account with the help of your SmartVestor Pro. Longer term purchases you are building a sinking fund can be things like your new (used) car purchase, home upgrade, once in a lifetime family vacation or just undefined savings, which most likely means it’ll be there for a while.
Lastly some will set up specific savings accounts with their bank or brokerage account with their investment firm, and even name that specific account the item they are saving for so they know every transaction is going directly to that fund. They can arrange to have set dollar amounts be transferred into these various accounts each month, or they will manually move money into the various accounts.
How do I create a sinking fund?
As I said earlier, normally the money you are putting aside for a sinking fund, you are aware of the dollar amount you’re a targeting for. If you know your yearly car insurance payment is $1,200 due in January, then you know each month you must set aside $100 into your car insurance sinking fund starting every January through the end of the year. If you roughly spend $800 on Christmas each year, and it’s May, you need to take $800 and divide it by 8 months (months left until December). Then for each month, set aside $100 so come December, you have that $800 readily available for you.
Is a sinking fund different than my emergency fund?
100% different. An emergency fund is only to be used for emergencies…meaning an unplanned/unexpected expense.
Please don’t confuse the two. These two need to be kept separate, and you should never dip from your emergency fund to put money in one of your sinking funds. Your emergency fund is supposed to be used for unexpected medical expenses, an unfortune accident (personally, to your car, house, etc.); anything that has a cost associated with it, that you were NOT expecting, and would cause instant panic and stress if this emergency fund did not exist.
Can a sinking fund cause harm?
Yes, if done incorrectly. Sinking funds can be a great budgeting tool, but remember to take care of your necessities first, before putting money aside for your wants. Don’t be starting a vacation sinking fund because you heard it can help you budget for a fun getaway. You must first make sure you are putting your money into the categories it NEEDS to be put into to pay off bills, pay debts, or even building your emergency fund first. Don’t make your sinking fund unrealistic with the money you have coming in, and the dollars you know that need to go out each month.