Ever heard of a sinking fund? I hadn’t heard of it until a few months ago, but understood the principles right away. Understanding what a sinking fund is can be incredibly beneficial to your budget. A sinking fund is a category in a budget that adds up each month, and only occasionally is spent.
The part of budgeting that frustrates me is the occasional big bills that come out of your account throughout the year. It could be car insurance, Christmas, house projects or transportation costs. A few years ago my wife started implementing a sinking fund for Christmas. We just didn’t call it a sinking fund. What was nice about our “sinking fund” was that when Thanksgiving rolled around, we weren’t panicked about needing to come up with the money to buy Christmas presents. We just figured out what our budget was for Christmas and then divided it up by 12, giving us our monthly amount needed to be saved. We opened up a separate savings account at our credit union and we were set to start saving each month.
You may find yourself in a similar situation where you have big ticket items or recurring bills that happen once or twice a year. Here are a handful of examples to help you understand how Sinking Funds can work for you.
Example #1: Transportation Costs
If you own a car, you understand that there are costs to owning a car. There are tires to replace, oil to be changed, windshield wipers to be replaced, license tags and registration. These are all items we can budget for and set up sinking funds to cover the costs. You could even include replacing a car as a sinking fund. List out everything that you may need to do to maintain your car this year.
- Tires – we usually need to replace our tires every 2-3 years, so we can budget $200/year per car and buy good quality tires
- Oil Changes – normally we change the oil in our cars about 3-4 times a year. Depending on if you change the oil or you bring it to your Jiffy Lube, the cost may vary. We budget $40 for each oil change per car
- Car Registration – we know that we have to have our car registered each year, and yet we always forget to budget for it until the month before. Our cars range in cost, but it is usually between $100-$200 each year.
Now there are going to be a lot more, but if we were to add up these examples we would be around $1,070 per year. At $1,070 each year, we would be setting aside $90 each month into our transportation fund. When you get an oil change or register your car, the money comes out of your transportation sinking fund.
Example #2: Christmas
We know when Christmas is coming. It comes every year on the same day. December 25th! It is no secret! And yet, we always seem to put it off saving for Christmas until it is too late. Then what do we do? We pull out the credit card! To prepare your sinking fund for Christmas, simply write down everyone you buy Christmas presents for and how much you plan to spend on them.
Tip: You could look back at November and December’s credit card statements or bank statements to get an idea of how much you spent last year.
Once you add up the total, let’s say that it comes out to $1,500, you would divide that by 12 and save $125 each month. I have loved this sinking fund over the last few years as it has really saved our budget. One thing I love even more, is that we usually have over-budgeted for it and we have a nice roll over fund and get a head start on next years’ fund.
Example #3: Car Insurance/Life Insurance
In many cases, car insurance and life insurance policies renew either every 6 months or every year. If your policy is $600 every 6 months, then you need to budget $100 each month for the car insurance sinking fund. Then once the renewal period hits, you just withdrawal the full amount and make your payment. Our car insurance company allows for us to just pay monthly without an increase in the premium. You may want to check with your insurance company to see if you can do the same.
Is there a Difference Between a Sinking Fund and an Emergency Fund?
There is a big difference between your sinking fund and your emergency fund. Your sinking fund is set up for the KNOWN and the emergency fund is set up for the UNKNOWN. The emergency fund will cover the totaled car, or an unexpected pregnancy. With your sinking fund, you know exactly what the money is for and you know approximately when you will use it.
Sounds easy right? So why don’t we all use this method? Well, because it involves something that a lot of us struggle with: patience. We have to have it now. We live in the give it to me now era. We have fast food, express checkouts, online shopping with express shipping. So if you have patience, saving up ahead of time prevents us from spending the money we don’t have.
Question: What are some of the sinking funds you have set up? Where do you normally keep it? You can leave a comment by clicking here.