Sinking funds may sound a bit strange they did to me for a while, but once you understand how they can help you build a safety net and reduce your stress, you’ll see them different.
What is a Sinking Fund?
A sinking fund is a pool of money that has a specific purpose mainly for a specific expense or category that we plan for. Their purpose is to cover those expenses without sinking the monthly budget or draining your emergency fund.
The Importance of Sinking Funds
One of the most stressful things that can happen related to our financial life is when that annual bill that we forgot about makes us use the credit card. Or coming back from vacation to realize that it’s going to take us more months to pay for all the great time we had.
Sinking funds are important for every household no matter the size or situation, because they increase financial stability towards other goals and bring peace to our decisions. It’s not the same to receive that notification that the car insurance payment will be drafted next week when you know the money has been saved in a sinking fund to when you need to scramble to find the money to prevent the overdraft or the high interests.
Types of Sinking Funds
Again these sinking funds need a specific purpose, if they don’t they’ll become another savings account and you’ll be tempted to draw money from it at anytime. The most important part of setting sinking funds is to give them a clear purpose, you’ll define that purpose taking into consideration: their use, the maximum amount and the time they will be used.
I’ll list some of the types of sinking funds I have or seen most commonly to give you some ideas, but remember you don’t want to start all of these at once, here we do one thing at a time. I’ll give you some guidance on how to choose your first one of your next.
- Christmas Fund: to buy christmas presents
- Vacation Fund: to cover all vacation related expenses
- Education Fund: for school supplies, uniforms/clothes, fees, field trips, cafeteria money, etc.
- Car Fund: repairs, maintenance, insurance
- Project Specific Fund: it can be a big purchase, a remodel, appliances, etc. I’m funding one to take an anniversary trip.
- Home Fund: unexpected repairs, insurance and property taxes if not on the mortgage.
- Health Fund: copays, deductibles, this one was very helpful to our family when we had a lot of copays for my son’s therapies
- Pet Fund: appointments, grooming, etc.
This list is just to give you a general idea of how to give purpose to a sinking fund but take into consideration your family needs to name those funds, there isn’t a right or wrong fund. You can have an entertainment fund to go to the theater or the movies or a self-care one to get a massage without regrets (I’m considering starting this one).
After the fund is named you’ll need to get specific. For example the Christmas fund, for whom I’m buying presents with this? How much money do I need there? Will I also want to include decorations in this fund? When can I start using this money?
All of those decisions made before hand will help you use your sinking fund efficiently and reap the benefits of having them, while keeping the emotion under control.
How to Set Up a Sinking Fund
Now let’s get your first or next sinking fund started. This are the steps we are going to follow:
- Pick your sinking fund type
- Give your fund purpose
- Decide where you’ll keep the fund
- Figure out how to fund it
- Relax
- Review and adjust
Pick your sinking fund type
Look back at the last 3 months, 6 months, last year what expense was hard on you and your family. Was it an insurance payment you forgot about? Was it the reality check after all the holiday expenses? What was a burden financially, emotionally or both? That expense is going to be an indicator of the fund we want to start.
My first one was a vacation fund, because I wanted to be able to enjoy the vacation without thinking if I had the money to pay everything later. That fund type brought peace and stability to our budget and financial life. I’ll continue to use this fund as my example in each step.
Give your fund purpose
Now be specific and this is a conversation you need to have with your spouse so we are all in the same page. What transactions will come out of this fund and when, how much money do we need on this fund, is it a one time thing or do we need to replenish it after being used. Making all this decisions before you have money there is so much easier.
Our vacation fund covers, traveling, lodging, food, shopping, parking, pet care to mention some whether during the vacation time or to be able to go on vacation. After figuring out what is coming out of the fund, you can set a realistic funding goal. I like to look at what we have spent previously to set that amount, or you can look at the destination if you have it on mind.
Decide where you’ll keep the fund
The most important thing here is do not keep it in your checking or main savings account. If you do you’ll be creating the illusion of a sinking fund but will still see it as spending money. You could create a second account on your current bank but it’s still way to easy to transfer the funds to main account because you’ll see it more often.
My recommendation is to open a high yield savings account for your sinking funds, I personally use Ally Bank for this, one of the benefits is the amount of interest you get. The second reason to have the account at another institution is that the transfer takes a few day, that would prevent using the money for something else.
My setup on Ally is to have one account for all the sinking funds, they have a bucket system that let’s me set goals and distribute the money on each different fund, also I can determine from which bucket the expenses are coming out. Look around at different banks and choose the best option for you.
Figure out how to fund it
Now that you have the amount your need and where to keep the money let’s figure out how do we put money in our funds. Based on the time you’ll need to use the fund and if it’s a new one there are a few things you can work with.
- The most basic one is diving the goal amount in the months you have left to fully fund it and transfer monthly.
- At the end of your budget period, weekly or monthly, transfer a portion of your leftover money.
- Use refunds, gifts, bonuses or any extra income to lump sum build your funds. This works great to get one fully funded and work on a next one.
- Once you get some money on your account, keep your interest there to build them up. In the beginning it won’t be much but it will help as you continue to build them.
- If you have a credit card that offers cash back rewards transfer them to your sinking fund account.
- Using apps to get some extra money, selling things, odd jobs are all good ways to fund your goals.
Start with one way the easiest one for you, keep this in mind the fund is going to help you later and you need to be ok with being a bit uncomfortable while you fund it to have peace later.
Relax
After you have set a plan in motion relax and be patient. You might not be able to fully fund it quickly or you might get other expenses that will tempt you to get the money out. Breathe and relax you made this decision of starting a sinking fund to help your family trust that decision.
Review and adjust
After reaching your goal, review the process of funding it. What have you learned? What can you adjust. After using the fund review if the amount is still realistic or was it too high or too low?
Mainly look at how it impacted the season where you used it, the impact to the budget, to your emotional health. Based on all that make adjustments for refilling them or creating new ones.
Making Sinking Funds Work for You
Don’t just create sinking funds to say you have them, give them purpose and trust the process. They will help you prevent new debt and also to achieve the financial stability that you and your family are longing for.
