A rainy day is only a paycheck away according to a survey done by Lendingclub.com that revealed that 64% of Americans are living paycheck to paycheck (2023). An unexpected expense could force some Americans to dip into their savings or spend on a credit card. With inflation on the rise and a looming recession, it’s more important than ever to get your finances in order. One way you can create a safety net for yourself is by setting up a sinking fund.
A sinking fund is a savings account you set up in anticipation for an expense that you expect to occur within a certain time frame. One example of a sinking fund is a Christmas sinking fund. You know Christmas happens without fail, every year, on the same day. If you were to set up a sinking fund on January 1st, you could commit to putting away $100 a month through the month December. By Christmas, you will have $1200 saved up in an account budgeted specifically for Christmas spending. This will take the strain off of coming up with that same amount of money in December. It may even prevent heavy December credit card usage which could save you money on interest throughout the following year. Keep reading to find out more about sinking funds, why you need one (or several), and how to set one up.
Why You Need a Sinking Fund
Sinking funds are a way to take your savings to the next level. They allow you to take a closer look at the most important things you will spend your money on throughout the year and beyond. In turn you can streamline your finances and reduce the stress that comes with expenses you should have expected but which instead have caught you unprepared. By utilizing sinking funds in how you manage your finances, you can be proactive about large recurring expenses or slowly siphon barely noticeable amounts each month toward that designer bag you always wanted. When you go on that vacation you’ve been saving for in a vacation sinking fund, you know that the money is dedicated to this specific expense. You can spend it guilt free and without any untoward repercussions to your day to day financial homeostasis.
How to Set Up a Sinking Fund (Calculation Included):
- Decide what your sinking fund will be dedicated to.
- Talk to your bank or credit union about adding a savings account to your current account. Set this up while being mindful of any minimum balance limits or associated fees.
- Estimate as accurately as possible how much you will need to fund your chosen expense.
- Calculate how much you will need to save per month or pay period.
- Here’s how:
- Take the total amount needed to fund your expense and divide it by how many months you will need to save up for it. For example, if you want to go on vacation in one year that will cost $1000, divide $1000 by 12 (months). You will need to save $83.33 a month for the next 12 months to fund your vacation. If you get paid bi-weekly, this is only $41.67 per paycheck.
- Here’s how:
- Every month or every 2 weeks you can go into your account and transfer this amount into your sinking fund until your goal is reached! If you are interested in automating this transfer, speak with your bank or credit union to set it up.
- Repeat this process for any other sinking funds you would like to set up!
Pro Tip: You can set up your sinking fund in many ways. You can have a cash envelope you add to each month, a piggy bank, a personal safe, or even an old pickle jar with a label on it! The method is not as important as you taking the time to calculate how much you will need over what period of time and then taking action to save!
Managing Sinking Funds
Deciding Which Sinking Funds to Prioritize
You can create a sinking fund for just about anything. Some ideas for sinking funds that might take priority over discretionary spending sinking funds include home and vehicle maintenance, major holidays and birthdays, taxes, weddings, planned medical procedures with out of pocket expenses and planned additions to your family such as pregnancy or adoption. Many of these ideas listed might have a higher priority for you than say a new Chanel purse or a month long Summer backpacking excursion through Europe. It is up to you to decide what is most important to plan for financially in your life.
How to Track Sinking Fund Progress
There are several ways you can track your sinking fund progress. One way is by downloading a worksheet from Etsy or Pinterest that has a fun graphic with spaces that you can fill in each time you save toward your goal. You can also start off with a worksheet that has the amount you are saving each month listed however many times you will be saving it. Each time you have deposited that amount into your sinking fund you can cross off the listed amount until they are all gone. A third way is to just monitor your savings account statements when they arrive from your financial institution each month. There are many creative ways to make the process of saving in a sinking fund enjoyable and rewarding .
Reallocate Sinking Funds Based On Your Financial Goals
If you already calculated the total amount you want to save in your sinking fund and you want to reach your goal in a shorter amount of time, simply divide the remaining amount needed by the number of months you want to reach the goal within. You will divide the total amount by the shorter number of months. In this case, the amount saved per month will likely increase due to your more aggressive timetable. If your savings goal can be spread out over a longer time frame, you can divide the total savings goal by the increased total number of months you have to reach the goal within. It all works relatively the same and the terms of your sinking funds are fully customizable based on your personal preferences and financial situation.
In some cases you might come into unexpected income throughout the year. These occurrences might be in the form of a work bonus, tax return, birthday gift, inheritance or other financial blessing. Instead of immediately spending this bonus money on an impulse purchase or dinner out, you can instead allocate at least a portion of it to whatever sinking funds you have in progress. This could shave off time from your savings progress and help you achieve your goals much faster.
Sinking Funds Vs Emergency Funds
Not to be confused with emergency funds, sinking funds are secondary savings accounts or envelopes that you contribute to on a recurring basis for a set amount of time with a particular end goal in mind. Sinking funds are for large financial goals and expenses you can expect. Examples of sinking fund expenses include regular oil changes on your vehicle, major holiday and birthday expenses, a family vacation, or a large purchase you want to buy for yourself or a loved one.
Emergency funds are savings totaling 3 months, 6 months or a year’s worth of your monthly expenses that you set aside and do not touch until you suffer a true financial emergency. Examples of emergencies that would warrant tapping into your emergency fund include unexpected job loss, serious illness or bodily injury, unexpected major necessary repairs to a vehicle (not routine maintenance), and the list goes on. For more information on emergency funds and how you can set one up for yourself, click the button below to read more.
Conclusion
In conclusion, sinking funds are a great way to streamline your personal finances. Not to be confused with emergency funds which are for unexpected large expenses and emergencies, sinking funds are savings you put money into in preparation for expenses you can anticipate. You can use sinking funds to save up for a personal goal such as a vacation, gift to yourself or a loved one, or a fun experience. You can also use sinking funds to save up for anticipated big expenses or recurring holidays and home or vehicle maintenance.
Overall, sinking funds can help improve your financial security, may reduce your credit card usage and subsequently save you money on credit card interest payments over time. Your financial stability and security can improve with regular use of sinking funds. As a result you can reduce the stress and anxiety that come with facing a large expense that you could have already saved for had you been more proactive. Overall, I hope that you are able to find value from my explanation of how sinking funds can help you improve how you go about managing your personal finances.
