Sinking funds are vital to your debt-free journey becuase they prevent future financial disasters. Save your budget by creating sinking funds and give yourself the chance to reach your goals.
Are you wondering if sinking funds should be added to your budget?
Once you begin budgeting there can be a sense of overwhelm.
How can you reach your goals when you still have so many other financial obligations?
Yes, people vacation while on a debt-free journey. And Christmas comes on the same day in the same month every single year.
And both of these things cost $$$$$.
So how can you save for these things and have them not wreck your budget in the process?
That is where sinking funds come in.
Let’s talk about them and why they are important.
What is a sinking fund?
Simply put, a sinking fund is when you save monthly for a planned or expected expense.
Christmas is a perfect example.
Christmas is something we spend money on every year and it can really weigh heavy on our budget.
That is why sinking funds are important.
Intentionally saving an allotted amount of money each month allows us to pay for something like Christmas without any added stress.
The term sinking fund is derived by companies when they essentially pay off debt or bonds.
And that is exactly how they will act for your budget.
Companies see the benefit because it saves them from interest and potential long term hardships.
Why do you need a sinking fund?
So you stay out of debt.
When committing to a debt-free journey you are vouching not only to pay off debt but also to stay out of debt.
Imagine working so hard to pay off debt only to go into more debt.
Sinking funds prepare you for future expenses so you don’t have to borrow more money.
Referencing Christmas.
If you work hard all year without saving for Christmas, how will you afford to pay for it?
Probably by going into debt.
Sinking funds prevent you from taking 3 steps forward and 2 steps back.
This is how sinking funds will save your budget.
Categories of sinking funds
You are going to have your own set of sinking fund categories.
Here are some sinking fund examples that are more common and popular.
- Christmas and holidays
- Vacations and travel
- Medical expenses
- Car maintenance
- Yearly subscription memberships/certifications
- Home repairs
- Child or pet care
- Large purchases (cars, technology, furniture, education, Taxes)
- Small purchases (clothing, beauty, gifts, splurge items)
These are just to name a few.
Click here to download my sinking fund printable worksheet
sinking-fund-worksheet
How do you know what categories to make a sinking fund?
I want you to brainstorm some possible sinking fund categories for yourself.
What are some things that you EXPECT or WANT to be able to pay for in the future?
Look back at your bank statements and see where you spent your money.
Things like Amazon prime memberships, car registration fees, medical copays, weddings.
These are things that you know you are going to have to pay for, but aren’t a part of your regular monthly budget.
Maybe you want to upgrade your computer, or start getting eyelash extensions.
You need a way to pay for those larger expenses.
Remember your budget is your PERSONAL MONEY MANUAL.
No one can tell you what to and what not to spend your money on.
So make a list of all the possible things you may want to save for.
Another way to tell if you should create a sinking fund category for that expense item is…
if you wouldn’t be able to cash flow the expense the month that it is due.
Let’s say you are in someones wedding.
Would you be able to fund all those expenses without derailing your budget?
Another good example would be gifts.
Such as birthday gifts, wedding gifts, shower gifts.
When someone’s birthday is in that month can you budget in the $20, $50, or $100 to pay for that gift? Or would you rather pull from an already saved pool of money?
This is important because…
It is possible to have too many sinking funds?
You can end up saving so much money that you have nothing left to put towards your financial goals.
Having too many sinking fund categories will slow your progress.
Remember the main purpose of sinking funds is to protect our budget and keep you out of debt.
That is why something like Christmas is such a popular category.
Christmas can be really expensive.
And it can be difficult to come up with sometimes a few hundred to thousands of dollars in one month.
Or even two months.
That is when you save a little bit over time to slowly build up to that larger amount.
Travel is another great example.
Because travel can be so expensive saving smaller amounts monthly makes it much more manageable.
The difference between sinking funds and an emergency fund
When is it good to make something a sinking fund and when do you use your emergency fund?
Emergency funds are for just that emergencies.
Christmas not an emergency.
Vacations not an emergency.
Tires for you car, doesn’t have to be an emergency.
Let’s define this again.
Sinking funds are a pool of money saved over time for an irregular or expected expense.
An emergency fund is a safety net for future misfortunes and unexpected expenses like a job loss.
That is the difference.
You can have a medical emergency or a home emergency but in reality those can be planned for.
We all know at some point our roof will need to be replaced.
You can make that a sinking fund so when the time does come you don’t have to use your emergency fund to cover it.
Those who have a smaller emergency fund really should have sinking funds
If you have a larger emergency fund, let’s say 3-12 months. It will be less vital for you to have as many sinking funds.
You could cover the cost of a roof if it suddenly became a problem.
If you only have $1,000 in savings, you will likely need another $9,000 to cover the cost of a roof.
And that is where the added debt comes in.
So if you are someone that has a small emergency fund please consider these “larger” expenses:
- Pets
- Children
- Medical
- Homes
- Cars
These are things that have the potential to be extremely expensive. Where a small emergency fund just would not suffice.
Even if you have a larger emergency fund, sinking funds can still be of value to you.
For instance my dog Max.
Pets are a liability.
Back in April we had to take him to the emergency vet and it was $500.
Having a sinking fund for him means not only do I not have to touch my emergency fund I also don’t have to pull money from that months budget.
Which means I stay on track to reach my goals.
How much to add to your sinking funds?
Here is another million dollar question.
How much do I add to my sinking funds?
Estimate, or come up with an exact amount of money for each of your categories.
Christmas for example…
You want to save $1,000.
Now you may need more, you may need less, but try and do your best to estimate.
Remember if you need more, I don’t think you’ll be mad about already having $1,000.
Now divide that number by the number of months you have to save.
It’s January when I’m writing this so I have about 12 months. That means I need to save about $83.00 per month to reach my $1,000 goal.
Let’s take a category that doesn’t have an end date.
Like saving for car maintenance.
Go back and research how much you spent on your car last year.
Registration, repairs, oil changes, tires, brakes.
Obviously, some of these won’t be needed every year but it will give you a good starting amount.
Divide that by 12 months and save that amount every month. Save until you have an amount you are comfortable with.
I would recommend maybe around the 1-3 thousand dollar mark. That means you can pay for a major repair like a transmission.
Also consider your situation.
Is your dog old?
Is your hot water tank old?
Are you going to need a new mattress in the near future?
Do you know someone that may get engaged?
Think about how dire or relevant that category is to you.
If your car is newer, a transmission replacement although possible, may not be something you have to save for.
Where to keep your sinking funds?
The best place to keep your sinking funds is either in a high yield savings account or simply in cash.
The best high yield savings accounts are Ally and Capital One 360.
Your bank may offer the option for multiple savings accounts as well but I don’t usually recommend those.
High yield savings accounts are better because they have higher interest rates.
This is my number one recommendation.
If you choose a high yield savings account (yes you can have multiple accounts for all of your different categories) it will take a day or 3 to get your money back.
If that is a problem then I would recommend cash or using a spreadsheet if you keep it in the bank.
For example if you are choosing to create a beauty sinking fund that will encompass things like hair cuts, pedicures, eyelash extensions, and makeup, you may want to keep that close by.
You will want access to that cash when and if you need to make a trip to Ulta.
If you are saving for something like a vacation and know you won’t need that money for a while open an HYS account.
I use capital one 360 because that is the credit card we hold.
It is very easy to set up and that is how we saved for our newest car purchase.
We wanted the money separate so we could track it, not have immediate access to it, and have it accrue higher interest because this was a long-term goal.
What if you don’t have a lot of money for sinking funds?
Consider upping your emergency fund.
Before you can really start paying off debt you need to make sure you have some savings.
Having savings is what keeps you from accruing more debt.
If you only have a little bit of wiggle room each month I would suggest whatever category is most relevant.
Like Christmas.
It comes every year, it’s not an emergency and it can be expensive.
Remember, if you are in the red at the end of every month, you have an income problem or a spending problem
Re-evaluate your budget first, and then come back to tackle your sinking funds.
Do you have to have sinking funds?
No you don’t have to have sinking funds.
If you are already debt-free or have a substantial emergency fund, you don’t have to have them.
Also, if you are someone throwing thousands of dollars towards your goals every month, you can most likely cash flow a lot.
After Michael and I paid off all of our debt we decided to start cash flowing Christmas.
We can fully pay for Christmas with no stress on our budget.
We do use sinking funds for savings outside of our emergency fund.
Such as vacations, house projects, and our latest purchase my new car.
We didn’t need a new car but knew that it was something we wanted to purchase in the near future.
Every month we moved some money into our Capital one 360 until we had enough to purchase it.
I wish I could say we were actively saving for a vacation but you know… a pandemic.
That is something else we would use a sinking fund for.
Currently, we are starting to save small amounts every month for a kitchen remodel.
The reason we don’t have a bunch of sinking fund categories is because most things we can cash flow.
We are currently cash flowing all medical expenses, car repairs, holidays, and purchasing other things as needed.
You don’t have to do it this way but it works for us.
Key points to how sinking funds will save your budget
- Sinking funds are meant for saving for a planned or expected expense
- You should keep your sinking funds in HYS accounts or cash
- Determine the amount you need and divide it by the number of months to come up with your fund amounts
- Analyze your expenses to find out what types of sinking fund categories you need
- Sinking funds are kept separate from your emergency fund
- If you have a small emergency fund or a low income you should have sinking funds
- Some of the most popular categories include holidays, car, home, medical, vacations, and self-employment taxes
What sinking fund categories do you have?
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