I love sinking funds. What are sinking funds? They are the perfect way to save for anyone a big cost.
Whether you’re planning a trip to Disney World or buying a new sofa or even a new car – sinking funds help you pay cash for it All of it and avoid the regret after purchase.
So let’s dive into how mutual funds work and how to create one so you can get a head start on your savings goals!
What Is a Sinking Fund?
A sinking fund is a strategic way to save money by setting aside a small amount of money each month.
Here’s how mutual funds work: Each month, you save a certain amount of money for a specific purpose to use later. That way, you save small amounts over time, instead of having to come up with a big chunk of money all at once.
Repayment funds work great for things you can’t or don’t want to pay for in one month’s budget, such as:
- New tires for your car
- Christmas gifts
- Vet bills
- Wedding expenses
- Airplane tickets
- Birthday parties
- Books and school supplies
- Clothes for a special occasion
- Holidays
- Home remodeling
- Concert tickets
You can create a sinking fund for any financial goal, dream or expense you have!
Sinking Fund vs. Savings Account
Mutual funds and savings accounts go hand in hand, but they are not the same. A savings account is place you save your money. And it is a sinking fund How you save your money.
If you’re trying to save for a new car, next year’s holiday, your birthday presents, your child’s dance camp, a all your Christmas presents in one savings account, that’s a lot to keep track of. Sooner or later, the lines will begin to blur.
So, instead of just throwing money into your savings account, you can create multiple sinking funds for specific purposes. This way, you’ll know exactly when you’ll reach your savings goals and how much you have to spend in each category.
Sinking Fund vs. Emergency Fund
A sinking fund is also different from an emergency fund. Very different.
A sinking fund is for those expenses you know are coming and you can plan ahead for – like your child’s soccer season or the bridesmaid dress you need for your friend’s wedding.
An emergency fund, on the other hand, is for unexpected expenses. For example, the air conditioner goes out, you get a flat tire, or one of your children chips a tooth.
You have no way of knowing if these things are coming or when they will happen. But because you are do know that life happens, you need to have the money set aside and ready to use. Your emergency fund is your safety net between you and life.
Therefore, there is a sinking fund for the knownand there is an emergency fund for the unknown.
And while you might be tempted to dip into your emergency fund when that rug you really want is on sale or you’re trying to snag floor tickets to a concert, that no what is its purpose. Only use your emergency fund for real emergencies. And use sinking funds for everything else.
Advantages of Sinking Funds
Regardless of your financial inclinations—whether you’re a spender or a saver, a nerd or a free spirit—everyone can benefit from a sinking fund.
Want to take your family of four to the beach for a week? There is $1,500. Need a new roof? That will be $6,000. Then there’s your kids’ summer camps, the washing machine you need to replace soon, and that adult-sized scooter your husband only has have to get (Just my husband? Oh, right. Cool.)
And instead of putting everything on a credit card and making payments for months, you can save and pay for things in cash – even the big things. No sweat!
A repayment fund helps you to:
- Save for anything and everything. Be as specific as you want to ensure you cover every need and want on your list.
- Plan for great, extravagant fun. This makes my spender heart so happy. Upgrade your kitchen, take your dream trip, invest in your hobbies, or give generously. Make room for fun by telling your money what to do, month after month.
- Let go of the guilt of a big purchase. Decide in advance (with your spouse, if you have one) what you are saving for and how much money you would like to set aside. When it comes time to spend it, you can do it without worry or regret – and most importantly, without going into debt.
- Prepare for those inevitable costs. When you see those tires wearing thin, start saving up for new ones. If you know the house you just bought has an old roof, start saving for a new one. These are not emergencies yet, and if you start saving now, they never will be!
Saving strategically means that fun purchases will actually be fun, and frustrating expenses won’t be a big deal.
How to Create a Sinking Fund
Now that you know what sinking funds are, how they work, and why they’ll help you, here’s how to create one in four easy steps.
Step 1: Decide what you’re saving for.
An Alaskan cruise, a down payment on a house, Christmas gifts, or a wedding reception. Whatever you’re saving for, you want to start planning for it now—so it doesn’t sneak up on you and make you break.
Step 2: Decide where you are going to store your sinking fund.
You can choose to open a separate savings account for your repayment fund. Make sure the account doesn’t have a minimum balance to maintain (like a money market account). You don’t want monthly fees to reduce your savings.
And if you use my favorite budgeting tool, EveryDollar, you don’t need a separate savings account at all. EveryDollar will designate that money for you in your budget so you always know exactly how much is in that fund. (More on this in Step 4.)
Step 3: Decide how much you need to save.
To calculate how much to save, take the total amount you want to spend and divide it by the number of months or weeks you have left until you need to buy.
If you want to spend $1,000 on Christmas and it’s September, you only have about three months to save. That means you’ll need a line item in your budget reminding you to save around $330 every month until December.
Step 4: Set your repayment fund in the budget.
A sinking fund will only work if it’s in your monthly budget. So, whether you’re budgeting with a spreadsheet, in an app, or with pencil and paper, put your sinking fund line item in the budget!
Here’s exactly how to create a sinking fund in the EveryDollar budgeting app:
Open your EveryDollar budget, find the Savings category, and click Add Item.
Then, name that budget item whatever you’d like your sinking fund to be called (for example, Christmas or Holidays).
Next, tap the new budget line you just created.
This will bring up the details of that budget line. Look for the piggy bank and Fund tap.
A graphic will appear explaining a little more about how funds work. Read it if you want all the details, then tap Make This a Fund.
Now it’s time to fill in your repayment fund details. Have you already saved some money towards this fund? If so, list that as your Starting Balance. Then, next to Planned This Month, type in whatever amount you’re giving to the fund this month. Finally, next to Goal Amount, type the total amount you want to save for this repayment fund.
(Note, if you’re on the desktop version of EveryDollar, you’ll go through much the same process, but everything will appear on the right side of the screen.)
Congratulations! You have your own sinking fund.
Now you need to make sure you transfer that amount to your savings account for the month and track it in your budget every time you add money to the fund. (You can even add a due date if you need a reminder every month.)
Keep at it, and you’ll celebrate a money-filled Christmas this year — or whatever your goal is!
How Many Sinking Funds Should I Have?
Now that you know how amazing sinking funds are, you might want to create one for everything. But in this case, there really can be too much of a good thing.
If you’re trying to juggle a million repayment funds at once, you won’t see much progress with any of them. You can only save so much money each month, right? Depending on your current financial goals, you may be better off focusing on saving for a few things at a time.
Let me give you an example.
Here’s what it would look like to split $600 a month between six different sinking funds:
- $100 for vacation
- $300 for a new car for you
- $50 for a backyard makeover
- $50 for medical expenses
- $50 for auto repair
- $50 for home repairs
At the end of a year, your repayment fund totals would be:
- $1,200 for vacation
- $3,600 for a new car for you
- $600 for a backyard makeover
- $600 for medical expenses
- $600 for auto repair
- $600 for home repairs
OK, now imagine you’ve decided it’s time to change your car. You have two choices: Find a used car you can afford for $3,600, or use $600 to make repairs to your current car and keep saving until your car sinking fund grows a little bigger.
But here’s the third option: If you skip the backyard makeover and the holidays this year, you’ll have $5,400 to spend on a new car (for you). It’s all about what you choose to prioritize.
So, if there’s something you know you need to pay for soon or something you really want, do the math and decide if you can save for multiple things and still meet your savings goals. Don’t spread yourself too thin!
Don’t Let A Big Purchase Sin You
See what a difference a little strategic saving can make? Instead of panicking, you can be prepared. Instead of going into debt, you can pay in full. Instead of playing catch up, you can get ahead.
That’s the power of a sinking fund (and a good budget)!
We live in a culture where we buy now and pay later. We want stuff at once. And Amazon has made anything longer than two-day shipping seem like a crime.
But if you have patience and a plan, you know what you won’t have? Worried.
Saving up front keeps you from stress and broke – so start creating some sinking funds today!