Sinking Funds to the rescue! Preparing for an upcoming expense? Holidays, Vacations, Weddings, or even new tires for your car can be funded with your Sinking Fund.
In this post, we will cover a foundational element of a good budget: Sinking Funds. Building on the progress we’ve made together, this is a highly effective tool and further enhances Mêtis in your Money Matters.
Sinking Funds belong in every budget!
What is a Sinking Fund? How to use Sinking Funds.
Table of Contents
- 1 What is a Sinking Fund? How to use Sinking Funds.
- 1.1 The Definition of Sinking Funds
- 1.2 The purpose of Sinking Funds
- 2 How to set up and use a Sinking Fund
Feeling overwhelmed by a financial goal? This is a great way to automate the contributions and take the stress out of the process. Trying to prepare for upgrades to your house, family vacations, and/or upcoming holiday expenses? Meet your Sinking Funds! Let’s dive in, define, and compare some features with other common funds and investments.
The Definition of Sinking Funds
Your Sinking Fund breaks a future amount into small regular payments, made over time, that will allow you to reach your goal. I believe Sinking Funds work best as a liquid form of investment over the short(er) term (e.g. money market), and slightly more illiquid over the longer term (e.g. certificate of deposit). We will cover this in more detail, below.
New and veteran budget users will encounter expenses larger than the relative income of that particular pay period. Additionally, as we’ll discuss below, we want to avoid using Emergency funds or depleting Retirement accounts for dedicated items we know are forthcoming. What then shall we do to solve those financial needs?
Alleviate financial stressors: Sinking Funds are here to help! Use them to accomplish some necessary goals, and use them to spend your money without feeling pressure or guilt about it. As a proper feature in your budget, these Funds are here to serve a broad variety of needs and tasks.
The purpose of Sinking Funds
Your Sinking Fund serves a unique purpose within your personal and family finances. It can be easy to confuse the concept with a savings fund or emergency fund. However, in order to maximize the benefit and efficacy of Sinking Funds, it is important to understand the differences between these.
Here are some common line items within your budget and how they are different. As we’ve said, it is important to use your dedicated funds for their intended purposes.
Emergency Funds are there for the unexpected moments when your budget cannot cover the cost for that period. For example, let us say the last week of the month comes along and you are essentially through your monthly budget. If your child kicks a soccer ball through the basement window, then you set about getting it fixed (we’ve personally enjoyed that trip :). An Emergency Fund is exactly what you can use here!
Depending on the economy and rate of inflation, I also recommend Emergency Funds as a way to cover unemployment over 3-6 months, even up to a year. This time frame can expand or contract depending on several factors, and the key point is that Emergency Fund is there for Emergencies only.
In general, Savings Funds are great for building your wealth and are not necessarily “linked” to a specific target like with a Sinking Fund. However, I think a high-interest Savings Account could be a great way to house your Sinking Fund over a longer period. If you go this route, I would recommend setting up a separate savings account for each of your Sinking Funds.
Do make sure that you’re reading the details of the Savings Account to avoid any conflict with your Sinking Fund timelines. Things like minimum balances, or requirements for direct deposit, etc., are worth reviewing before hand.
These are great “clearing” accounts where direct deposits can be sent, and expenses or other investments are paid from. Checking accounts tend to have very low interest rates which could make them less ideal for housing your Sinking Fund(s). However, over the shorter term, the interest rate may not be as critical for your plan.
If you are using your Sinking Fund over the very short term, then a checking account could hold that for you. However, I would recommend not using your primary account as the co-mingling of funds could frustrate the process. Lots of places offer checking accounts, and just like the Savings Accounts, you’ll want to make sure and understand the details and terms of the account.
While the temptation to draw from the nest egg might be a real one for you, I urge you and encourage you to stay strong and avoid touching it! Sinking Funds are set up for a specific goal and are then spent on that goal. Want a family vacation? Have your cake and eat it too by setting up a Sinking Fund, leaving your Retirement Savings alone, and enjoying both guilt-free. Looking back, your older self will be so glad you did!
Examples of Common Uses for a Sinking Fund
Looking for some ideas on how to employ your Sinking Fund? Here, are ways to start:
I love this one! There is nothing like ‘no financial stress’ to enhance the quality of a vacation. Try this: we take our planned vacation costs (based on previous experiences and research on what we want to do) and divide that target number by the months we have until we want to arrive. For example, if we want $5,000 in two years: $5,000/ 24 = $208.34 per month and you’re there!
Note, anything longer than 2 years and I really try to find a high-interest account to use so I can maximize the use of my dollars. Also, I try to use that as a way to mitigate the impact of inflation, too (every little bit helps).
Christmas and Holiday Spending
My wife and I have used this method and find it really helps cut down on some holiday financial stress. To do this, we average our annual holiday savings over the last 3-5 years and then use that number as our starting point; it is our target amount.
Then, we divide that number over 12 months. The resulting amount is what we have set up automatic contributions for. Those contributions go into our high-interest savings account to be withdrawn in November or December for purposes of buying gifts and enjoying the Christmas holiday!
Another benefit – next year, we rinse and repeat! No need to close and open multiple accounts each time.
Home Repairs… and Tires!
These funds are effective for knocking out known updates, upgrades, or repairs to your primary residence. I don’t know about you, but I do not like spending big bucks on vehicles: I paid to buy them, pay to license them, pay to insure them, pay to maintain them – they are a quintessential black hole for our dollars! We’ve found Sinking Funds to be an effective way to save for necessary maintenance such as new tires.
Additionally, Sinking Funds are great for planned upgrades or updates to the house. Need to update the kitchen? What about a landscaping project? Not to worry! Follow the steps outlined below to get started.
How to set up and use a Sinking Fund
Ready to put your dollars to work? Here, we’ll talk about the logistics and getting the money snowball rolling. You can do this! Here’s how:
Sinking Fund Categories
Start by thinking about what you’ll need to plan in advance for. In this post, we’ve covered some financial needs we’ve encountered and listed them as an example. Sinking funds have a broad range of applications and utility for any goal!
- Auto Repairs
- New Car
- Home Repairs/ Updates
- Preparing for a new baby
- Annual Subscriptions (ie amazon prime)
- Annual Propane Bill (or other utility paid annually)
- Furniture Purchases
- Annual Taxes
Did I miss anything? Leave a comment below!
With that financial target in mind, write down the category, the date you’ll need the money, and the amount of money you’ll need at that time.
Calculating Contributions for Sinking Funds
Also, take a moment to investigate how much you’ll need to contribute over time. As referenced earlier in the post, you also need to account for interest and inflation. Think about this as the time value of money, and remember that inflation (especially at the time of this post) can degrade your purchasing power over time. This may not be as big a deal if you have a fixed cost that you know will not change when you reach the goal of your Sinking Fund. However, if the costs are dynamic, you’ll really want to pay attention to the changes in prices over time and plan accordingly.
This calculator does a good job breaking down the amount into smaller chunks. A Sinking Fund calculator is an exercise in the points we outlined in the previous paragraph. Here’s another simplified calculator to help get an idea.
Where to house your Sinking Fund?
Now that you’ve identified your dates, amounts, and contribution amounts it is time to find a safe place to house your Sinking Fund. Earlier, we talked about a few options. See if Checking or Savings Accounts, Certificates of Deposit, or Money Market Accounts are a good fit for you! Often times you can check with your local bank, too. However, I think it is always a good idea to shop it around and see what you can find online before signing up.
Sinking Fund Tracker
With it set up, calculations, and account setup complete, you’re well on your way to achieving your financial goal! For me, tracking was one of the easier steps. If you’ve completed the calculations and have defined the amount you need to save each month, then the next part is to automate those contributions. Take the guesswork out, take the administration efforts out, and focus on the rest of your life. I very much encourage automation in that regard. Check-in during your weekly budget reconciliation efforts, watch the number grow, and take pride in what you are doing to better your financial situation!