Complete Guide To Sinking Funds And How To Make Them Work For You

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sinking fund

One of my favorite tools that I have in my budgeting and saving arsenal is a sinking fund. Have you heard of them before? Sinking funds are key when it comes to staying on top of your budget.

Do you dread those months of going to the mailbox to find that unfavorable bill from the car insurance company requesting payment for your insurance policy? What about other large purchases such as new tires for your car or a new washing machine because yours just broke?

How do you plan for things that will inevitably happen at some point in your life? Do you dip into your emergency fund, do you use your credit card or are you prepared with a sinking fund?

As we all know big lump sum payments can wreak havoc on our budgets if we aren’t prepared. Having a system in place to help you pay for these expenses can really help you from spiraling out of control and falling into debt.

What Is A Sinking Fund?

A sinking fund is a budget category that is set up as a way to save money by setting aside a little bit each month to pay for large expenses.

Sinking funds are a great way to divide your savings throughout the year so you aren’t hit with that car insurance bill that you aren’t able to afford.

Basically you are putting money aside now to help you afford expenses later.

For example, every December and June I have to pay my 6 month car insurance bill which is $538. December is the absolute worst time to be hit with a bill like this because of the holidays.  

However I have created a sinking fund for my car insurance in which I save $90 a month throughout the year. This makes the large amount due much more tolerable on my budget.

I know when December comes around I have the money set aside in my sinking fund, so there’s no stressing or worrying about how I can afford this.

Did you know that the average American saves just 3.8% of the income they bring home each month? By having a sinking fund and being prepared for large sum bills you’ll be able to keep your finances healthy.

sinking fund

How Does A Sinking Fund Work?

Having different expenses or infrequent bills throughout the year can really mess with your budget if you aren’t prepared. Not having a sinking fund can cause you to have to scramble to pay the latest expense or bill.  

Sinking funds are key to creating a consistent and predictable budget each and every month. They prevent you from stressing to find extra cash and avoid the possibility of falling behind financially or even into debt.

How To Set Up A Sinking Fund?

When setting up you sinking fund the first thing you will want to do is decide where you want to keep it. A couple things to keep in mind when deciding where to put your money is to keep it accessible to you.

What I’m saying is that you don’t want to have to jump through hoops and pay any penalties for withdrawing your money.

The second thing to do for your sinking fund is keep it in a safe, low risk account. A sinking fund is not money you should plan on making an investment from by putting it in a high risk account. You want to keep it safe so the money is there when you need it most.

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    Where To Put Your Sinking Fund?

    Depending on your budgeting style there are 3 different options when it comes to where you should put your sinking fund.

    My first recommendation is a combined high yield savings account for all your funds. My second recommendation is individual high yield savings accounts. And last but not least is the cash envelope system.  

    Combined Savings

    Having one combined savings account allows you to keep all your sinking fund money in one easy to find place. If you decide to go this route make sure you have a way to keep track of how much money you assign each category so you have the appropriate amount when needed.

    Several Small Checking Or Savings Accounts (one for each sinking fund)

    If your bank allows you to open multiple accounts without accruing any fees this is a good option because you can have an account for each sinking fund.

    sinking fund

    Cash Envelope System

    Last but not least you can create a sinking fund within your cash envelope system. Not sure what the cash envelope system is all about? You can read all about it here!

    If you go the cash route I recommend you keep your cash safe by using something like this.

    Keep in mind when starting a sinking fund account you need a good budget to start from. It’s very hard to keep adding money to sinking funds if you haven’t created a budget.

    The best budget for beginners that I always recommend is the zero based budget because of its simplicity and that it accounts for every dollar in your budget.

    **Pro Tip**

    I highly recommend keeping your sinking fund money in a separate account than your everyday money. By having them separate you will know that this money is set aside for a specific fund.

    Putting your sink fund money into your everyday account will just complicate things and make your budgeting more stressful than it needs to be! 😉

    Why Do You Need A Sinking Fund?

    If you are living on a budget where you feel that one large bill could push you over the edge a sinking fund is something you could benefit greatly from.  

    Having a sinking fund reduces financial stress and the unexpected surprise when large purchases need to be made. Having a sinking fund guarantees that your bills will be paid on time and that you won’t have any problems with falling behind on payments.  

    The last thing we want to see is someone go into debt to pay a bill they weren’t prepared for. By having a sinking fund you won’t be surprised when a bill arrives because you have the comfort of you know…. you sinking fund!

    Sinking Fund Categories You Should Set Up

    As we all know there are the surprise bi yearly or yearly bills that arrive in our mailbox rain or shine! To be prepared its best to take an inventory of your own circumstances and what you need to be saving money for.

    One person may need a vacation sinking fund, someone else may need a home owner association sinking fund, and another person like myself may have a car insurance sinking fund.  The vacation sinking fund sounds much more fun doesn’t it?

    As you can see each person’s story is unique therefore everyone’s sinking funds are going to be different.  Because I can’t tell you exactly what YOU should budget for I’ve created a list of sinking fund categories that are pretty universal to most people

    Car Maintenance

    Owning a car comes with a great expense (tires, scheduled maintenance, oil change, brakes).  If you own a car it means at some point you will have to pay for some kind of repair or maintenance because there’ll be a time when that darn check engine light comes on causing you to have to go to the shop.

    Travel

    Ok here comes the fun sinking fund. To be honest this is my favorite! However, having a travel fund can come in two forms; one for pleasure and one that’s not so pleasurable.

    Let’s start with pleasure. The yearly family vacation to Mexico. The bucket list vacation to Africa- you name it you can save for it.

    On the opposite side of pleasure comes the unfortunate occurrence of funerals or illness.  I know, I just took the fun right out of travel.

    However, we never know when a loved one may pass or become terminally ill causing us to travel across the country. By having a travel sinking fund it will assure you you can afford a last minute plane ticket.

    Home Repair/Maintenance

    If you own a home it’s inevitable that something will need to be repaired at some point. It may be something small (which we all hope for) or something large like a brand new roof!

    You never know when something unfortunate like a roof repair may happen to you.  Sure! Your insurance may cover some but you will still need money in reserves just in case.

    Home repairs are NEVER cheap. Being prepared with a sinking fund will prove to be your best friend.

    sinking fund

    Medical Expenses

    Illness and accidents happen!  Even if you are lucky enough to not visit the doctor you may need money to pay for prescriptions, vitamins contacts/glasses, or even a physical therapist.

    Electronics or Technology

    If you are anything like me you’ve spilled water on the keyboard of your laptop or dropped your phone and cracked the screen.  

    Both of these instances are quite frustrating. But not being able to afford fixing them is even more frustrating. Having the keyboard on my computer inoperable when I had an assignment due was almost my breaking point in frustration.

    Optional Sinking Fund Categories- (various other things you may chose to save for)

    • Gifts
    • Clothing
    • Income Tax
    • School Tuition
    • Car Insurance
    • Pets
    • Kids Activities
    • Holidays
    • House Decorating

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      How Much Money To Put In Each Sinking Fund?

      How much you put into each sinking fund depends on how much each expense costs. I’m a big fan of determining the total cost of bills for your sinking funds then dividing them into smaller more manageable amounts.

      Here’s an example

      1. Determine the amount of money you want saved in each sinking fund.

       If you you want to have $1200 saved for a travel fund you need to save $1200. If you want to have $2000 stashed away for your car that’s on the fritz then make that a budget goal.

      2. Determine the date you want the money saved by

      For me, I know that my car insurance sinking fund is due two times a year once in Dec and once in June so in order to afford the $538 every 6 months or 1,076 every year I stash $90 a month into my car insurance sinking fund.

      If you want to take a family vacation in the summer write down the month that you anticipate needing the money by.

      3. Determine the amount of months you have to save until you will need the money

      As mentioned above if you need the money in June and December you will need to make sure that you plan accordingly.

      If it’s currently Dec and you just paid your car insurance you know that you have another 6 months to save up to make your next payment.

      4. Do the math

      Divide the amount of money necessary by the amount of months you have to save. Then you simply begin stashing that amount away into your categorized sinking fund.

      5. Stop saving money in your sinking fund once you have reached the amount needed

      Once you have reached the predetermined amount in each fund you can stop saving.

      Yes. I don’t recommend saving more than necessary in a sinking fund because there are better things to do with your money than “over save” in your sinking fund. A couple good investment options are to either invest your money in a retirement account or put money into a HSA.

      RELATED:

      How To Track The Balance Of A Sinking Fund?

      If you have your sinking funds in individual banking accounts the bank will do all of the tracking for you. If you prefer to have a quick and easy method to track all of your money in one place I highly recommend using Personal Capital.

      If you are using the large combined account method where you deposit your sinking fund money into one account you can track it on an excel spreadsheet.

      If you are using the cash envelope system for your sinking fund you can write the balance on the front of each envelope. Here’s a great template for creating your own free envelopes for the cash envelope system.

      Sinking Fund Vs Emergency Fund

      Please don’t get confused between a sinking fund and an emergency fund. They really are different.

      Sinking funds are designated for planned expenses that you’ve budgeted specifically for. An emergency fund is for? You guessed it emergencies!

      Creating an emergency fund is specific for unplanned, unexpected events. Not sure how to set up an emergency fund? Don’t miss this guide that walks you through everything you need to know about emergency funds.

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      Final Thoughts

      Sinking funds can really change how you manage your money. You can start with just one or two that make the most sense for you. The choice is yours when it comes to sinking funds!

      If you use sinking funds for something that isn’t listed above, let me know in the comments below because I’m always open to good and creative ideas.

      Don’t forget to share and pin for later! While you’re there, I’d love for you to follow me on Pinterest

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