Sinking Funds 101
Most of us know about debt and saving on a general level, but today we’re going to go over something that will bring your financial game to a new level -- sinking funds.
Sinking funds are different from emergency funds or different savings accounts because they go directly toward a bill or other expense.
Sinking funds are a strategic way to save up money for something in the future by putting aside a small amount of money every month.
This way, instead of getting blindsided by a bill for thousands of dollars, you’re prepared for it in advance. You might also save money because most companies offer deals when you pay a year in full.
It doesn’t necessarily have to be bills, either. You can use the sinking fund strategy to save up for a guilt-free dream vacation.
Some things that classify as sinking funds:
- Health insurance
- Car insurance
- Fancy dinners out
Once you’re done saving for them, you have the freedom of being able to stop thinking about each fund and can do other things with your money during the year. For example, if you saved up for your sinking funds by April, you would have the rest of the year to not worry about your big expenses. Wouldn't that be the dream?
Where should you put your sinking funds?
In order to avoid confusion and overlap, you should open a new checking account specifically for these funds. It will keep your sinking funds separate from your regular spending account so you don’t accidentally spend the money you’ve saved for.
How many sinking funds should you have?
If you’re still busy paying off debt or saving for your emergency fund, those are your priorities before you move onto anything else.
Before you overwhelm yourself with the amount of bills you have each year, I’d highly recommend you start with two to five important goals to get you used to building and completing a sinking fund.
Once your debt is paid off and you have a fully-funded emergency fund, you can then start working toward all of your sinking funds. For reference, I have about 19 or 20 each year.
How do you pay towards a sinking fund?
You pay toward your sinking fund in the order in which they are due. If you build financial flow charts, you can put them in that order to make sure you’re on top of your bills as they come in.
How do you build a sinking fund?
Now we’re to the fun part where it’s time to start building sinking funds.
You’ll want to take a look at your bills through the year. Some can only work on a set pay period, such as monthly, but some allow you to pay in a lump sum and also get a discount for doing so.
Let’s use an example of an internet bill at $100 per month. That equals $1,200 per year.
How do you decide how much you need to save for your sinking fund?
Take the total amount that needs to be saved and divide it by the number of months (or weeks) you have left until you need to make the purchase.
If your bill above is due by June and it’s January, that means you have six months to save $1,200. Your financial flow chart “bricks” would be $200 per brick. I highlight each “brick” as I put that money aside for my sinking fund.
If it’s too stressful and it’s too much money to save for at a time, don’t feel bad. It’s perfectly fine if you can even just save a chunk at a time so it’s not as painful when the bill is due. Also, there’s nothing wrong with paying monthly bills and only saving for one sinking fund if that’s what your situation allows at this time.
What about sinking funds with variable amounts?
If you’re saving for something like a vacation, where you don’t know the exact cost down to the penny, let’s go over how you would figure this out.
First, you’ll want to get rough costs. You could tally up the current going rates for the flight, the hotel, the car or Lyft, and any other major parts. That should give you a number to start with. Then, you’ll want to include the extracurricular parts such as food, experiences, and extras.