A sinking fund is a simple budgeting method that allows you to prepare in advance for future purchases and allocate a certain amount each month or week to pay for these.
Have you ever felt like sinking into the ground after splashing out on a long-desired purchase? Let’s face it, we’ve all been there. A sinking fund can help you be prepared for larger expenses.
What Is a Sinking Fund?
Dave Ramsey, a well-known financial advisor has suggested using the sinking fund method.
How exactly does a sinking fund work?
Let’s say you are looking to buy that $1,000 laptop – for your spouse, of course – by Christmas.
- If it is April, a sinking fund has 8 months left to work its magic.
- Divide $1,000 by those 8 months and you get a set amount of $125 to put aside per month for that category.
Is a Sinking Fund the Same as General Savings?
Unlike general savings, a sinking fund gives you a specific purchase goal and a way to get there.
Savings accounts may be used for anything under the sun. Whereas a sinking fund is an allocated amount of money intentionally set aside to pay for, say, that outfit for a friends’ wedding, or new tires.
What About My Emergency Fund | Does That Need To Change?
A sinking fund can be a game-changer, but may not be as crucial as 3-6 months saved in an emergency fund.
Basically, an emergency fund is a safety net for the unknown expenses that life may throw. A sinking fund is a deliberate saving for a known and specific cause.
How Does a Sinking Fund Fit on a Budget?
It may be as simple as adding a line to your budget and reallocating expenses from there, depending on what you are saving for.
The following are 4 key steps to implementing a sinking fund:
1. Identify What You Are Saving For
Identifying what the purchase is and the exact cost has to be step number one. Larger expenses such as roof repairs or family vacation are a good idea to prepare for months in advance.
2. Choose Where Your Fund Will Be
Whether in the form of an envelope of cash or an interest-bearing savings account, a sinking fund gives you the flexibility to control the amount kept aside.
However, be mindful of bank fees if you create a specified account, as these can inch up your expenses over time.
On the other hand, if you decide to keep a fund in the form of physical cash, ensure the security and the safety of where that will be stored.
3. Decide How Much To Save
It is necessary to decide how much you need and how much you are prepared to save. Take that total amount and divide it between the number of months or weeks you have left before the purchase date.
You can also decide what months you will or won’t have enough left over to devote funds. This allows for flexibility if you are a variable income earner.
4. Add a Line To Your Budget
Regardless of what kind of budget you have, by adding a row or line specifically for your monthly or weekly payments towards your end purchase, a sinking fund can easily be implemented.
Having a sinking fund does not have to, and, ideally, should not replace debt repayments, savings, or emergency funds.
A Simple Method
Starting a sinking fund is a simple and transparent means of regaining better control overspending, and keeping some certainty over the future. Avoiding credit debts and loan repayments can alleviate worry and guilt, and elevate your peace of mind.