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December 29, 2020

What are sinking funds and where do they fit in your budget?

A sinking fund is a strategic way to save money for an expense that you are anticipating. The actual expense can be anything, a medical bill, car insurance, Christmas gifts, vacation or down payment — or all of these things at the same time!

Types of expenses to save for in sinking funds:

Coming up with your sinking fund categories can seem overwhelming at first, but you probably already have a fairly good idea of what your major expenses could be for the next 6-12 months. Have you noticed your laptop making a weird noise every time you open it? Will you be moving in 6 months? Do you want to start saving up for your own house?

If you’re ready to start brainstorming for your sinking fund expenses? There are three categories of expenses to include in a sinking fund:

How to save in sinking funds

Clearly, sinking funds are important. If you’re struggling to save, however, it can often feel like there’s just not enough money to stretch and save for all the sinking fund categories you just came up with. Luckily, you don’t have to save up for everything at the same time.

Once you determine the categories for your sinking fund, you have to create a schedule to regularly contribute enough money to cover that specific expense by the time the bill or event arises. Let’s look at an example:

In January 2021, you create the following schedule:

Say you have $1,000 you can attribute to savings each month. Here’s what a schedule could look like:

You can break these monthly amounts further into weekly goals or ‘per-paycheck’ numbers based on the rest of your budgeting schedule. If you are just starting out, creating a calendar in your daily planner or even a new notebook is beginner-friendly and more forgiving of errors.

Where to organize money for sinking funds

There are many ways to organize sinking funds, and some may work better for your lifestyle than others. If you struggle with spending too much and are following a cash envelope system like Dave Ramsay’s, you can have separate envelopes for all your sinking fund categories and save in cash. Other people use an excel spreadsheet or a notebook to track their contributions to various sinking funds but transfer everything to one main savings account (although we would recommend separating out your emergency fund and other savings into two separate savings accounts). Yet another method is to actually open a separate savings account for each sinking fund category. Most banks will allow you to have multiple savings accounts. You can even rename the savings account to be the name of your sinking fund.

The difference between sinking funds and emergency funds

A sinking fund is generally used to cover a planned expense whereas an emergency fund exists to cover unplanned expenses. If you can approximate the amount and timeline of a future event, it is no longer an emergency.

An emergency fund is setting money aside for the unexpected. Your goal should be to have 3-6 months of expenses saved for all possible life emergencies like layoffs or emergency medical expenses.

Both of these savings strategies will make you feel more at ease when it comes time to needing the money, but they are created for very different reasons. In general, we recommend saving up 3 months of emergency funds first, then continuing to build your emergency fund (perhaps at a slower rate) while also saving in your sinking funds.

The importance of having sinking funds

Sinking funds give you better control of your money. Setting aside money in advance for upcoming expenses prevents the need to tap your long-term savings or rack up credit card debt. Instead of swiping your credit card in a panic, then figuring out how to pay for it later, you’ll use cash that you’ve been setting aside each month to cover any costs that you anticipated.

Spending or splurging on things that you want is not bad. You can go on vacations, treat your family members, and replace your electronics and furniture when you want. But like anything worthwhile, it takes some work and dedication to get there. Some planning and scheduling will surely lead to great financial results and conscience-free spending!

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