What is a sinking fund? And how does it help your budget? Read this post to read why sinking funds are your budget’s best kept secret!
Guest post from Jessi of JessiFearon.com:
There’s sort of this best-kept secret in the world of budgeting and all things personal finance. Maybe you’ve heard of it before or maybe it’s a new concept. Regardless, I have to tell you about it because it has saved our family’s financial life more times than I can count!
So, what is this mysterious secret? Sinking Funds.
Yeah, I know, it doesn’t sound all Hollywood glamour but trust me, these bad boys work!
What is a Sinking Fund?
A Sinking Fund is a separate entity fund that you fund from your monthly household budget for a specific purpose. So in our household, we have Sinking Funds for auto-related expenses, home-related expenses, Christmas, and Vacations (we’re still working on setting up one for healthcare).
Each one of these Sinking Funds is a separate bank account (we use online banks for these as they typically don’t charge you bank fees) that we keep funded. For example, in our Auto Fund, we prefer to have a minimum of $1,000 in that account. So if we use that account and the balance dips below a $1,000 then that Fund becomes a priority in our household budget to bring the balance back up.
How does this help your budget?
To illustrate this, let’s talk about Edna. Edna was my husband’s 2006 Chevy Colorado. Back when we were first married in 2009, Edna started having issues. She spent a ton of time in the shop and no one could figure out what was wrong with her. Long story short, we ended up paying over $5,000 trying to fix a problem that should have only cost us around $20 to fix.
The issue is that we were newlyweds and I was still in college — meaning, we were broke. We not only drained our checking and savings accounts to pay for this mystery repair but we also put a lot of it on a credit card. To say that we were stressed was an understatement! But the outcome of this stressful event was the creation of our Auto Sinking Fund.
Our Auto Fund exists to keep a similar situation from ever occurring again. Now whenever one of our vehicles needs a repair or even just regular maintenance like an oil change or tires, we just take the debit card that is linked to the Auto Fund and pay for it. There’s no stress on our household budget for that month. And we get to avoid having to dip into the Emergency Fund to pay for it.
How do you set up a Sinking Fund?
The key to setting up Sinking Funds is to remember that you’re not going to be able to set them all up all at once. You’re going to need to take some time to build up these funds. I suggest you start with the most pressing Fund that your household needs in place. For my household that was the Auto-Fund but maybe for your household, it’s the Healthcare Fund or Home Fund.
Regardless of what Fund you decide to start with, pick one and then determine a minimum balance threshold. Again, with our Auto-Fund the threshold is $1,000. If you picked a threshold of $1,000 then you would work to build that account up to $1,000. Then once you’ve achieved that goal, you’d then pause contributing to that Sinking Fund and then start building your next Sinking Fund.
Why banking accounts and not cash?
For most of our Sinking Funds, we use bank accounts to save versus keeping them in cash. Mainly this is due to the fact that I’m married to a Spender and keeping money just hanging around is a little too tempting. Also, we’re both not comfortable having thousands of dollars just sitting in our home.
However, we have used the cash method before to build up certain Sinking Funds. Mainly those types of Funds are “quick” ones. Meaning, they’re going to get used up sooner rather than later. For example, when my husband was turning 30 we were still on the debt-free journey. However, I still wanted to gift him something special. He had his eye on this massive cabinet saw (my husband is a Master Carpenter), but it was $700. So, I set up a Sinking Fund where I set aside a certain amount of money from our budget every month into an envelope to build up the cash I needed to hand him on his birthday to go buy his saw.
That type of Sinking Fund is more temporary than our other ones. So using cash to build up Sinking Funds is a great idea when it is a temporary type of Fund, but for the more “guaranteed” type of events, I think an actual bank account should be used.
How do you budget for these Sinking Funds?
To budget for these Sinking Funds, take the minimum threshold balance you decide on and determine how quickly you want to save up. For example, if your threshold is $1,000 and you want it saved up in three months you’ll need to set aside at least $334 every month to achieve that goal. You could then further break that down into how much you need to set aside from each paycheck. If you’re going to receive two paychecks in a particular month, you’d have to set aside at least $167 from each paycheck to achieve your goal.
It takes a lot of self-discipline to achieve these types of goals but I have no doubts that you can do it! Trust me, once you start using Sinking Funds, you’ll be in a much better spot financially! You’ll also be less stressed! Nothing compares to the radiator blowing in your car and not having to stress out over the repair costs because all you have to do is go into your Auto Fund to pay for it. Honestly, it is an incredible feeling not having that stress of financial doom lurking over your head!
Do you use Sinking Funds currently? Have you thought about starting one?
Jessi Fearon is a wife and mom to three little kiddos. Her family paid off just over $55k of debt in 2 years and they’re now 100% debt-free after paying off their mortgage in January 2019 – all on a $47,000/year salary. She loves coaching others towards achieving their dream life by learning to manage their money and embracing their own real life on a budget.
Subscribe for free email updates from Money Saving Mom® and get my Guide to Freezer Cooking for free!