Personally, the term ‘sinking fund’ is new to me. Thanks to my parents, I have known the principles behind a sinking fund for a long time, but the term is new to me. My parents set up a special savings account and named it based on what they were saving for. In most cases, they would be saving for a new car in a few years so they could buy one without having to finance a car.
In a nutshell, this is what a sinking fund is, but there is so much more you need to know.
Culturally, I think the idea of a sinking fund has been lost in the United States. We want instant gratification. The patience to save for a new car in a few years is hard to find. It’s now so easy to fund items too! Today, with Afterpay or Klarna, we can even finance the purchase of simple items such as a new shirt from Lululemon. Easy access to financing options only reinforces the habits of impatience we’ve developed.
People not using a sinking fund is something I’ve observed in recent years.
We actually started doing the opposite. We take out a loan to pay for the item first. As an immediate gratification cost, we pay interest on that loan. To save our money, we need to save first, maybe even earn some interest on that savings, and then buy the item.
What is a sinking fund?
As I have hinted, a sinking fund is a special savings account that you set up to save for a big purchase. We will discuss what the fund can be used for later.
The term ‘sinking fund’ comes from business.
“A sinking fund is a fund that contains money set aside or saved to pay off a debt or bond. A company that issues debt will have to pay off that debt in the future, and the sinking fund helps ease the rigors of a major expense of revenue. A sinking fund is being established so that the company can contribute to the fund in the years prior to the bond’s maturity date.” (Investigatedia)
Difference between a sinking fund and an emergency fund
There is one big difference between a sinking fund and an emergency fund.
As we have already learned, a sinking fund is used to help save for a large purchase. An emergency fund can also be used for large purchases. The main difference between the two is that one fund is used for planned purchases (sinking fund) and the other is used for unplanned purchases (emergency fund).
I don’t want to go into too much detail about emergency funds because we already have an article about that. In this article, we learn that they are for those unplanned expenses that life can throw at you. Some expenses that an emergency fund can be used for include:
Broken device Car repairs Job loss
Sinking funds, on the other hand, are designed to help you save for large one-time expenses.
Types of sinking funds
Some types of large one-time sinking funds include:
New appliances Home repair Home renovation New car Medical expenses (human or pet) Vacations
They can also be used for larger recurring expenses. My wife and I use our regular checking account for these expenses. We tend to keep a solid five-figure balance in our checking account, on top of our emergency and sinking funds, just for these recurring expenses.
Auto Insurance Auto Registration Renewal Christmas/Birthday Gifts Summer Camp Back to School Shopping Annual Subscriptions (Software, Streaming, etc.)
Best Ways to Save for One
It’s really not that hard to start saving for a sinking fund. First, you start with a dollar amount for what you want to save, such as a $5,000 vacation. Then you think about how long you still have to save for that holiday. Let’s say 10 months for this example. We can calculate how much to save each month by dividing $5,000 by 10 months. In our example, we need to save $500 each month.
Once you know this monthly amount, you need to figure out how it fits into your monthly budget. Our holiday fund is third in line for priority. First we need to contribute towards retirement, then our emergency fund needs to be full ($15,000 in our case), then we meet our monthly amount for our sinking fund. The remaining amount goes into our checking account to make sure it’s filled enough for those recurring expenses.
Finally, you should put your money in an account that earns you interest while you save. This account can be a high-yield checking account or even a money market account. We personally keep ours in a conservative fund within Betterment. I like this option because we can make an automatic deposit into the fund. It takes effort to salvage from the equation.
5 tips for success with a declining fund
1. Separate
Keep your sinking fund money separate from the rest of your money. This gives that money a focused goal. It’s easy to get distracted from your goals. If your money was in your general pool, it would be easy to tap into.
2. Name:
Naming your fund can also help you stay focused. You can name your fund “New Furnance” or “Disney Vacation”. A name will help remind you what you’re saving for.
3. Automate
If possible, automate the deposits into your fund. This helps ensure that no deposit is missed so that you stay on track with your savings goal. Autodeposit also helps eliminate the possibility of coming up with an excuse not to deposit this month because you want to buy something else.
4. Windfalls
If it makes sense, deposit any extra money you could earn, such as a bonus or tax refund. This will help speed up the savings process and get you to your goal faster.
5. Prioritize
Some sinking funds will have a higher priority than others. Be sure to focus on those first as compared to those that may be a “want” rather than a “need”.
Conclusion
A sinking fund is a powerful yet simple financing tool that allows you to save for large one-time or recurring expenses. They help you buy items like cars or vacations so you don’t have to go into more debt.
This article is not intended to knock you, the reader. I’m not perfect either. My wife and I financed a new car that we bought last summer. We did a cost-benefit analysis and waited for a deal on the financing, 1% APR. The moral of this short story, financing sometimes makes sense. I’m not here to make you feel bad about making an informed decision to fund anything.
While they take a lot of patience and focus, sinking funds can help you keep your finances healthy rather than just financing to buy items.
If you’re looking for more income to help you save your sinking fund, we’ve got a page for you! Over the years, Andrew and I have slowly compiled a huge list of ways to make money. To look at! You might find something you like!
Wallet Squirrel is a personal finance blog by best friends Andrew & Adam about how money works, building sideline businesses and the benefits of investing the profits smartly. Featured on MSN Money, AOL Finance and more!
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This post Budget for major expenses with a declining fund
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