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The essential nature of a sinking fund when a family has financial goals is undisputed. Sinking funds can help take the pressure off the urgency to meet a certain long-term need and put measures in place to help you secure financial satisfaction.
In this article, we are going to walk you through a need to save money for the future over long periods of time so let’s get straight into it.
What is a Sinking Fund?
A sinking fund is a smart money move which financially aware people make when they want to save money. It can also use to reach a financial goal.
It is the act of setting aside small amounts of money periodically in order to slowly yet steadily save up for a financial goal. For example, you can take a few hundred dollars out of your monthly expenses to save towards a car.
The goal of setting up a sinking fund often varies. It might be to pay off debt, to make a purchase, settle an upcoming expense or even to go on a holiday. Any venture that requires a lump sum which will be inconveniencing to set aside all at once can fall under a fund category.
Tell Me the Purpose of Sinking Funds?
There are many different reasons that one can have sinking funds. So here are some very important ones.
We all have inevitable purchases that we worry about more than we should. Christmas gifts, baby expenses, car repairs, maintenance costs. the list is a rather lengthy one. These are things we know will weigh on our bank accounts when the time comes and a sinking fund helps you plan ahead. You can have money set aside money periodically to ease the pressure of those costs when the inevitable comes.
Secondly, you get to save yourself from pinching out of other parts of your budget. That’s how sinking funds work. Let’s say you have a basic budget for needs and other things that might be important to you. When times for the purchases come and you do not have any sinking fund saved up, you will have to pinch from other parts of your budget such as your emergency fund or even your savings. This will set you back and further engrain the mentality that he who fails to plan, plans to fail.
The next reason to have a sinking fund is because of the safety element to it. There is a chance that you will not be able to afford certain expenses if you choose to be spontaneous about them. This affords you an extra layer of security to be sure those expenses are catered for. This is especially helpful with necessary expenses like dental costs, car repairs and more. You do not want to get back into a wall or have to take out a loan and put yourself in debt as a result.
Final reason of sinking funds
Even though the reasons to create sinking funds are endless, the final reason we will give you is that it helps cushion you against impulse spending. When you inculcate the culture of sinking funds, you can easily combat impulse spending by creating a sinking fund for those things you cannot get your eyes off of. It is safe to say that it is a form of therapy for impulse spenders, isn’t it?
Moving on, let’s get into the different categories of sinking funds that exist.
Give me examples of sinking fund categories
There are many different sinking fund categories and for this purpose of this section, we will be exploring a few of them so let’s dive right in.
A sinking fund category are those things that you dedicate your funds to. We are going to go through some common sinking funds categories used in family budgeting.
Health Care Costs
Unless you know how to mix magic potions, you most definitely visit at least one health care professional once in a year. A doctor, a dentist, an optician or anyone really to help with your wellbeing.
Health care is not cheap but at the same time, it is the most essential facet to a high standard of living. Unfortunate but true. You might want to open a sinking fund so you do not panic when you need a check-up.
Annual Renewal expenses
There are certain subscriptions that make your life significantly better. If you work in language, it might be grammar checkers, or it could be Netflix subscriptions or even trackers. Any yearly subscriptions that help you and are hefty will most certainly included. This is especially important if it costs a significant sum.
This is also beneficial considering that annual subscriptions are significantly cheaper than monthly ones and same goes for the next category.
Insurance Premiums
If you pay off your insurance in one fell swoop, there is a high chance that you will save a lot on it rather than making the payment each month.
Annual plans are much more discounted so here is something that makes so much sense. Instead of paying a lump sum every month, opt for annual plans and create an insurance sinking fund. Ensure you have an active plan then ahead of your next payment, use this method to save yourself some coins.
Insurance is extremely important as an individual or as a family. It is one of the many ways in which you can purchase security.
Car Repair Fund
If you own a car, you know by now that it is not cheap or easy to maintain. Even if you do not have to endure car repairs, you most definitely have to run routine maintenance or car insurance.
That should be a very important aspect of your sinking fund as the health of your car also determines your safety.
You can also get your vehicle taken off the road if it isn’t maintained. These are worries you shouldn’t have to deal with in one sitting. With sinking funds, you do not have to burden yourself with it when the time comes.
Christmas sinking fund
One thing that has been consistent throughout this article is the fact that a lot of the sinking funds you will create stem from inevitable things and the most inevitable thing of all, is Christmas.
When Christmas rolls around you will definitely need to buy presents, attend events, meet up with friends and more. The entire holiday season is just a book of activities and your wallet really shouldn’t be crying when all has been said and done. A sinking fund will save your bank account from paying for these expenses.
Vacation sinking fund
A lack of leisure is the thief of joy so you should opt for one or two vacations a year. It is good for the soul. Whether you are going to a destination or visiting family in the country, a getaway is always a good idea.
Vacation sinking funds will help you plan a vacation of your dreams without necessarily paying for it from a place of gross inconvenience.
It will also help you to plan much more lavish vacations. When you know months in advance that you need to plan a trip, you can leave room for a bigger budget and instead of going a few towns over, you might save up and visit a neighboring country. How wonderful!
Childcare
A separate fund to care for your kids and pay their fees, meet their needs and save up for summer activities is the peak of good parenting. Kids are just as adorable as they are expensive and a sinking fund will help you with those expenses.
Planning for a new baby and the expenses thereof also falls under the categories of this sinking fund. The price of a new born is alarming and that will put tons of pressure on you as a new parent.
Maintenance costs
Maintenance is extremely import and this has a ton of subcategories under it. House maintenance costs, body care and much more. If you can plan for these things on advance then you are getting your life together little by little.
Pet Care
Pet care is also very costly, almost as costly as kids so you might want to plan for it. Pets are basically part of the family and just not neglect them when you are creating sinking funds.
Everything from their washing to their cleaning and even save their training cost, even before getting the pet.
Frivolities
When we explored the purposes of sinking funds, we told you that the strategy can be used to cushion against impulse spending. When you allow yourself some pleasures, this falls under frivolities. You can have a sinking fund for a designer item of your choice or just to treat yourself to something nice.
We all have guilty pleasures when it comes to impulse spending and this is an amazing way to curb that.
As we can go on and on about multiple sinking fund categories that exist but we will have to stop here. We hope you understand the idea of sinking fund categories and how you are able to tailor it to your needs.
Difference between Sinking Fund and Emergency Fund
The difference between sinking funds and an emergency fund is the intention towards the money.
An emergency fund is something you start saving without even knowing what you are going to use it for. The sole purpose is unforeseen future expenses and unexpected costs whereas a sinking fund has a specific purpose.
Emergency funds are put in a separate savings account to help with any type of unplanned occurrence. This could be an urgent home repair, an electrocuted appliance, medical expenses for an accident or even losing your job. All these are things your emergency fund should cater for.
On the other hand, a sinking fund is purposeful and not protective. You know what exactly you are going to use it for while you hope you don’t ever really have to use your emergency fund.
Tell me the difference between a sinking fund and a savings account?
With sinking funds, you are planning for a specific goal and the purpose of that money is to be spent. With the money you put in a savings account, the goal is often to build wealth and accumulate more money and not necessarily spend that money.
Sinking funds are saved to be spent on a specific need but with savings, that is not the case.
Also with savings, there is no specific amount you need to save. This makes it a permanent fund. You can save as much as you want whereas with a sinking fund there is a target you need to reach and once you reach it, that is the end of that sinking fund category as you will take the money and go spend it.
Is sinking funds a need or a desire?
A sinking fund can be one of both and it can be both. It all depends on the fund categories.
For example, a medical sinking fund can be categorized as a need because you need health care. A vacation fund on the other hand can be categorized as a want as you will still very much breathe and be fine if you do not have a vacation fund.
Nevertheless, a sinking fund as a concept is a financial need if you want to be able to spend money without inconveniencing yourself.
So the short answer is yes, a sinking fund can be a need.
How many sinking funds should I have?
Sinking funds are an essential part of personal finance which means no one can tell you how many you should have. You can never have too many sinking funds as long as you have the means to get fund them all at the end of the day.
Simply, you can have multiple sinking funds categories to the extent where your income can comfortably cater for it but if you are unable to, then you might have too many.
When you notice that you have too many sinking funds, you might want to consider cutting them down in order of necessity. After you satisfy the ones you choose, you can move on to others.
How do sinking funds help me budget better?
Earlier in the article, we spoke about how sinking funds will help cushion against impulse spending. Unlike an emergency fund, a savings account or other goals, sinking funds are very different.
You can create sinking fund categories for things that are guilty pleasures so that you do not have to take out of money that would have been spent wisely.
It is also very important for expenses that are inevitable as saving money little by little for those expenses is very convenient as your budget for a certain month doesn’t get to suffer for it.
Sinking fund money can be used in a plethora of different ways so you do not have to worry too much when budgeting.
Sinking Fund Formula
We all hate math but then for this concept to help you out, your sinking funds categories need to have a formula. Luckily for you, there is a formula to help you set aside money in your different sinking fund categories.
The formula is simply: How many much money you need divided by how many months you have equals to how much you need to save every month.
A sinking fund formula will help you create these fund categories with ease. You should also be realistic with your time frames as well.
For example, lets say you need to make a down payment of $3000 for a car in a six months and you will like to save money for it.
That would be $3000 divided by six and that would be $500 dollars in your car sinking fund account every month for six months. At the end of six months, you will have enough for a car.
So now, how do you set up a sinking fund budget.
How to budget sinking funds?
There are many different steps when you want to budget sinking funds and we are going to get into all of them in this category.
Decide The Type of Sinking Fund
A sinking funds category is very different from a sinking fund type.
There are two types of sinking funds: a revolving sinking fund and a short-term sinking fund. Revolving sinking funds are expenses which reoccur again and again even after the last one has been paid.
For example, medical expenses are revolving/reoccurring while a new car is a one off or a short-term sinking fund. Once you know this, you can move to the next step.
Using Sinking Funds Formula, Decide Stipend
The formula we illustrated above can then be used to determine the amount of money y0u would need to input in your monthly payments.
Quote how you are going to pay this sinking fund
If you are going to pay from a salary or from an extra income source, then you can decide that. It is safe to say that any money quote for a sinking fund specifically, it has to be from a stable and steady income source.
Pay your Sinking funds
You can now set up a means to collect your sinking funds periodically.
You might want to set up a sinking funds tracker if you are going to set up a few sinking fund categories or more.
It is some sort of planner that would help you plan ahead and track your savings. A good tool is a software like MoneySpire.
Tell me the difference between sinking fund category and budget category?
The difference between sinking funds categories and a budget category is the consistency of spending.
Budget categories consist of regular and irregular expenses which are spent immediately such as food, transportation, fuel, savings and even money to go into sinking funds.
Sinking funds is when you are saving money to spend in the future.
As a matter of fact, multiple sinking funds fees are included in the budget categories. Simply put, budget categories are set to be spent immediately and regularly while sinking funds are saved for the future.
Where to keep sinking funds
You can set up sinking funds in a savings account. You can open several, separate savings accounts for each need but if you have short term sinking funds or small amounts to meet, you can use something as simple as cash envelopes of even a piggy bank. This is helpful if your need requires to pay cash as well.
You could also use a software called Digit, an automated savings service for automatically saving money.
Any way you choose to do this, you would need to consider the nature of the sinking funds. If the funds are a lot of money, you can consider a savings account.
But if it is for something like Christmas gifts, you can use cash envelopes because you can spend cash when you are shopping for those gifts.
Or if it is medical expenses, you can use a savings account. So you can send the money to your doctor when you fix an appointment.
The list goes on and on so for your specific sinking fund expense. You should be able to identify what is best.
Best tools to manage sinking funds
There are several tools that you can use to have money set aside. We have listed a few along the course of this article but we are going to list them out extensively.
Savings Accounts
You will want to keep your sinking funds separate from all the over savings. Also you can open several accounts for each purpose.
A savings account is a good idea because it is also a form of investment. As you probably know, money that is kept in a bank garners more and more interest over time. Especially money that is kept in a high yield savings account. This will afford you a sinking funds goal as well as an extra two percent interest on the side. A win on both sides if you ask me.
Physical Storage
This involves means such as cash envelopes, savings binders, piggy banks and lots more. You can save cash in physical places around you; just take them out to be used when want to use the money.
Digital Savings
There are a lot of scams out there specially when it comes to digital savings. But we are going to tell you about a fair few that are very reliable.
First, we have MoneySpire. A financial tracking and budgeting software that can help you handle your personal finances.
There is also Digit, an automated savings app. It will help you manage your money much more than you can without it.
FAQs About Sinking Funds
Luckily for this generation, we live in a world where more and more people become financially aware. This means that there are a lot of people asking about sinking funds.
In this section we will be exploring ten different most asked questions about sinking finds.
We might have answered these questions along the course of this article. But just for the sake of being straight forward, let us get into it.
Can I really have a sinking fun for anything?
Yes. you can have a sinking fund for absolutely anything you would like to save up for.
It is not a common term but there are people who create sinking funds for everything in the future. For example, people in long distance relationships might create sinking funds to visit their partners.
It all depend on the needs you have and what matters most to you.
How do I divide my sinking funds?
This question is very common but it only means that you have greatly misunderstood the concept.
You should have sinking fund categories with already mapped out with the different amounts using the formula we showed you above.
I hope that helps!
When do I stop saving for a sinking fund?
You can stop saving for a sinking fund when you reach your goal. Maybe that is why it is termed as sinking, because there is always a bottom.
You should always have a goal though. that is the most important thing.
Can I invest my sinking funds?
With the concept of investing over saving on the rise, you might want to invest your money. That is where the benefit of interest based savings accounts come in. You can ensure your money is accessible and garnering interest.
Even though the returns may not be as much as it would be if you invested in stocks or other high value methods, at least there are returns.
Do sinking finds count as savings?
Technically, yes they do. The only difference is that you are saving to spend towards a goal but like we explained, normal savings is to build wealth.
What happens when you use sink funding is that you help your savings stay intact.
Where should I take money out of to fund this?
As a general rule, you should take money out of your disposable income in order to be able to pay sinking funds accounts.
If you can not do that, you can also consider taking some money out of your the amount that would have been regular savings. This might sound wrong but if you do the maths, you will end up pinching your savings if you do not create a sinking fund anyway.
What is the biggest benefit of sinking funds?
The biggest benefit for me is the comfort that comes with sinking funds. The ease of not having to worry about money takes the seat over every other benefit.
The second best one would have to be the fact that you can do things much bigger than you would if it was a spontaneous expense.
Why is it called sinking funds?
The term ‘sinking’ is used because the distance to your goal is sinking. In a pool, a rock sinks slowly and steadily. That is exactly how this concept works hence the term.
Can a lot of people have a sinking fund?
A lot of people can come together to create sinking funds if the goal needs them to.
For example, you and your friends want to go on a vacation and booking a group trip will cost less that individual trips. Everyone can contribute monthly to the cause till the money is complete.
Concepts in finance are always tailored to the goal. With a goal, anything can be done.
What happens if the price of what I want increases by the time I reach my goal?
We live in a scary world nowadays and inflation is a huge financial concern. Nevertheless, for short term goals, you can either make a deposit, push the goal or pay the difference from your emergency fund(if it is an emergency) or disposable income. If the goal is short term, there wont be much of an interest anyways.
If it is long term, a financial analyst will be able to help you determine the rate of increase.
Conclusion
When spending money, you would need plan and if you love comfort and ease, you are most definitely going to love sinking funds.
That way, you can sleep easy knowing that there are needs and wants that will come up that you have already catered for. You really can purchase security.
Using tools that work best for you, you can comfortable take advantage of this process and alleviate worry.
We hope you enjoy the concept just as much as everyone who has ever used it does. Create that sinking fund today. You will certainly not regret doing so.