If you’ve heard the phrase “sinking funds” and wondered how it pertains to personal finance, this is the blog post for you. A sinking fund is simply a pool of money that you use to save for a specific expense. For example, if you own a car then you know that the car will need tires every 50,000 miles (or so). This isn’t a surprise expense. This isn’t an emergency expense. However, it can quickly become an unplanned expense. However, a sinking fund takes out the unplanned aspect and allows you to save for new tires on a monthly basis instead of freaking out when it is time for new tires and you don’t have the cash to pay for it.
Let’s look at an example using numbers:
New tires – $1000.00 (nice tires)
Annual mileage – 25,000 (you drive a lot)
Time to expected expense – 24 months
Savings per month – $41.67
So if you are planning to spend $1000 on tires every two years, you can set aside $41.67 per month into a sinking fund. This way, you can fully fund your new tire purchase with cash without touching your emergency fund, using a 90-days same as cash offer, or putting it on a credit card.
Where to Put the Sinking Fund Money?
Now that you have a better idea as to what a sinking fund is, you may be asking yourself where to store the money. Some people store the money in a cash envelope in their house and others store it in an interest-bearing checking account. I store my sinking fund money in an ING savings account. I choose ING because the money takes 48 hours to get to and I’m less likely to use it for an impulse purchase. Impulse purchases is one of my bad money habits and so for me, it is important that this money be out of reach from an impulse purchase perspective.
Although I have several sinking funds, I only have one physical sinking fund account. The account may have $1000 in there but a portion of it may be for the new tire sinking fund while another portion is for Christmas shopping. I keep track of how much I have in each of my individual, virtual sinking funds via a spreadsheet. So a monthly deposit of $200 to the sinking funds ING account may be earmarked for five different sinking funds. It may sound a little confusing at first but it is easy once you do it a few times.
Common Sinking Fund Items
Okay you know what a sinking fund is and you know where to put it, now on to what kind of sinking funds you need. This is going to vary by family and really puts the PERSONAL into PERSONAL FINANCE. Some families may be able to cash flow an oil change and tire rotation every 3 months while other families need to approach it from a sinking fund perspective.
So here is a list of some common sinking fund items that you can use to get started with your sinking fund accounts:
- Auto Repairs & Maintenance
- Tires
- Homeowner’s Insurance (not paid monthly)
- Clothing
- Vacations
- Birthdays and Other Celebrations
You can have as many or as few sinking funds as you need. Regardless of how many you choose, sinking funds are a great way to plan for expenses that aren’t unexpected but aren’t usually a part of the typical monthly budget.
Photo: alancleaver_2000
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