If you have been budgeting or listening to people that budget, you might’ve heard the term sinking fund. So let’s get into the details.
Sinking funds are funds periodically set aside that is completely separate from regular savings and emergency funds. Basically you build it up to your goal, deplete it and start over again. Some common sinking funds include: vacation, house repairs, car repairs, holidays, weddings, fun money, etc. You can have a sinking fund for anything you want to save for.
I like the idea of sinking funds because it’s a lot easier to put aside a small amount all year long instead of paying a lump sum. I really think it’s great for people with children. You can have a sinking fund for back to school, birthdays, and Christmas. All those events can get very expensive if you pay all at once. If you get paid every two weeks, you have 26 paychecks a year. If you put $20 into a back to school sinking fund, you’ll have $520 saved up after a year. $50 a check would be $1,300, $100 a check would be $2,600.
A sinking fund can be as small or large as you want it to be. Sinking funds help relive stress and make budgeting simpler. Car repairs are always annoying and seem to come at the worst times. Wouldn’t it be nice if you had a special account for car repairs? If you’ve been putting $10 or $20 away every few weeks into your car repair sinking fund, the surprise $500 repair just got that much easier to handle.
Umm..sounds like a savings account
So what’s the difference between a sinking fund and a savings account? There is not much difference but that small difference turns into something bigger. Let’s say you typically save $500 a month and put it in a regular savings account. That would be $6,000 a year. At the end of the year, you decide you have to have a new car. You decide to by a used car and use the $6,000 in savings. On one hand, it’s great that you didn’t take out additional debt. On the other hand, you have nothing left in savings. Let’s see what it looks like if you used sinking funds for that same $6,000.
$500 per month divided into four sinking fund categories:
- $50 for car repairs/ $600 after a year
- $50 for Christmas / $600 after a year
- $100 for vacation/ $1,200 after a year
- $300 for new car/ $3,600 after a year
In this example, you would have $3,600 to look for a new car. Don’t forget, you would also have $600 for car repairs. You might be able to fix your current car with that $600 and keep saving if $3,600 isn’t enough for a reliable car. You also still have money for vacation and Christmas. So even though both examples equal $6,000 at the end of the year, sinking funds help with the strategy of decision making.
How do I get started?
The simplest way to organize sinking funds is to have multiple accounts at the same bank. You can set up all your deposits to automatically disperse the set amount into each account. If you are someone that would bother your accounts and switch money back and forth, this option is not for you. It would be better to get different accounts at different banks to make it more difficult to move money. You have to be honest with yourself for this to work. You also have to hold yourself accountable so you don’t touch the money for a different reason. Get an accountability partner! It always helps to have a partner, especially on the fun sinking funds like vacation. Set a goal and decide on a destination once you’ve met it.
What do you think about sinking funds? Have you ever used them? Are you going to give them a try? Let me know in the comments below.
