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Sinking funds and why you need one.
Have you ever been stressed out about an upcoming bill, not knowing where you’d get the money to pay for it? Think of your annual taxes, bi-annual insurance premium, or summer camp for your kids.
Larger bills can be stressful and overwhelming to pay when you don’t have a plan in place. It often feels like the payments are always due and we never have enough time to save for them.
I was there too. My insurance premium is due every six months and before becoming debt free, that bill was always paid with a credit card.
Can you say fail?
Yes, I paid my insurance with a credit card, putting myself in debt each time. I was making monthly payments on my credit card to cover my insurance expense. I never really thought about all the interest I paid as a result.
It wasn’t until I started planning ahead that I realized I could save those monthly payments each month and have the money ready to pay my insurance. With this method, I would save all the money I normally paid to interest.
Fun fact: I still put my car insurance on my credit card, but now it’s for the benefit of accumulating points and rewards, haha. I make sure to pay my credit card balance in full each month, so I still avoid the interest.
But, I wish I knew about sinking funds during my struggle. It would have eliminated the stress that came with the lack of planning. It would have helped us take on a huge payment, one small payment at a time rather than all at once.
There’s definitely a better way to plan out those irregular expenses so you don’t have to worry every time the payment is due.
When it comes to making big purchases, paying a large bill or planning for future expenses, it’s all about having a sinking fund, my friend. It is the tool that would have made paying my bills and saving money much easier!
What is a sinking fund?
A sinking fund is a way for you to set aside money each month to pay a large upcoming bill or expense. It allows you to plan ahead and adjust your budget so you can account for those expected longer-term expenses.
A sinking fund helps you avoid using your emergency fund for non-emergency expenses. So, your emergency fund can be saved for it’s true purpose, the unexpected expenses.
The purpose of a sinking fund is to help you save money each month. You’ll be able to plan out your expenses in advance so that you are financially able to pay them in full when they are due.
How does a sinking fund work?
It’s essentially a regular savings account. As mentioned earlier, you deposit a set amount each month based on your upcoming expense(s).
You can either have one savings account and have a spreadsheet to organize your planned expenses, or you can set up several savings accounts to account for each expense.
How you set up your sinking funds is entirely up to you.
Here are some pros and cons of each method.
Single Sinking Fund
It’s easier to set up
Easier to keep track of and access
All money is in one account, making it harder to see what you have for each expense
You have to keep a separate spreadsheet to keep track of the balance based on expense
Multiple Sinking Funds
Each account clearly shows what you have for a specific expense
No additional spreadsheets to track each bill or purchase
Takes more time to set up, since you need several savings accounts opened
You have to keep track of which account is for what purpose based on the account numbers.
Why do you need a sinking fund?
There are many benefits to a sinking fund.
Your budget becomes more efficient and effective. Having sinking funds included in your budget will eliminate surprise expenses, since you’re accounting for them on a monthly basis.
And, as we established earlier, a sinking fund helps eliminate the worry over how you will pay your larger, irregular bills.
A sinking fund is a great tool to help you reach your financial goals and cash flow every aspect of your life. With it, you can save for fun things like Christmas presents and vacations. Or, you can choose to save for your dream home or new car.
The possibilities in what you can achieve with a sinking fund is limitless.
How to Set up a Sinking Fund
Step 1- What Account to Open?
It’s a pretty simple process of opening up one or more savings account. You want to stick with a liquid account so that you can access your funds anytime you need to.
You can go to My Bank Tracker to see which banks are the best for savings accounts.
Step 2- List Your Irregular Expenses
List the expenses by name and amount. Also, list all of your annual goals like vacation, money for gifts, or a down payment for a home.
You can use download this printable to get started.
Step 3- Include Your Sinking Fund Categories in Your Budget
If you don’t currently have a budget, this cheat sheet will walk you through how to create one.
You must have a budget for sinking funds to work properly. Your budget is very important to the process because you’ll know how much money you have to spare for these sinking funds.
A budget and sinking fund work side by side to ensure that your money has a purpose and direction.
Your budget takes care of your bills and your sinking fund takes care of future expenses, whether those are bills or planned purchases.
Step 4- Discipline and Focus
While this is not a logistical step, it is incredibly important if you want to be successful with your sinking funds.
When you begin to see your accounts grow each month, you may be tempted to spend the money on other things, especially if you’ve ever lived paycheck to paycheck in the past.
Keep focused on your goals and keep your hands off of the sinking funds. The more you let these funds grow, the more financially stable you’ll become.
No bill will ever stop you in your tracks again.
Did someone say “vacation”? Yes, please!