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In our June blog on Five Healthy Financial Habits, number five focused on saving for specific goals by putting aside a small amount toward those goals every month. That is basically the description of a sinking fund. Sinking funds can be used to pay down a debt or to save for a planned expense such as a trip, a car maintenance item (like a new set of tires), or an event like a birthday celebration, anniversary weekend away from it all, or Christmas. As the amount of money you save grows, the amount you need “sinks” (or shrinks, in other words). A sinking fund is separate from your emergency fund, but just as vital. Having both types of savings is important for your financial health.
Why are sinking funds important? Sinking funds are a useful financial tool that will help you manage your money wisely. A sinking fund is for a planned, expected expense. To determine how much you need to save, take the total amount to be spent and divide it by the number of months you have left until you need to make the purchase. For instance, if you establish a sinking fund for new tires which you fund with $75 every month, it will only take you six months to have $450 saved. Saving $75 a month hurts a lot less than pulling $450 out of your checking account or emergency fund, and tires are not really an emergency, they’re a necessity. This is an expense you know is coming at some point, so why not set up a sinking fund and have the money available when the time comes?
As mentioned above, a sinking fund is not an emergency fund. A sinking fund is a specific fund for a specific purpose, whereas an emergency fund is a fund for unexpected financial events, such as a job loss or unexpected health crisis. Both types of funds are important and necessary to keep your budgeting on track and be prepared for whatever may come, but they are not one and the same.
You may be wondering what types of expenses (besides new tires) qualify for a sinking fund, and how many you should have. Everyone’s budget and lifestyle are different, but here are some suggestions for things you might want to establish a sinking fund for:
1. Graduation party, gift, and/ or trip
2. Wedding
3. Honeymoon
4. Anniversary trip
5. New baby expenses (hospital bill, crib, equipment)
6. New car
7. Furniture
8. Large appliances (washer, dryer, refrigerator, stove)
9. Vacation
10. Christmas
11. Down payment on a house
12. Travel
By setting up sinking funds, you will be ready to take care of repairs and replacement of major items when it’s called for, before these things become emergencies. Because you have a separate fund for emergencies, you’ll also be prepared when the unexpected happens. Take a few minutes to write down expenses you know are in your future and start a sinking fund for each one. You can start with a small amount and build; don’t worry if you can’t put a lot of money in each sinking fund to begin with. The point is to start somewhere and build from there. If you find you have a few extra dollars in a budget category at the end of the month, move those dollars into a sinking fund and you’ll be amazed at how quickly you reach your sinking fund goals.