How and When to Use a Sinking Fund
Transitioning into a debt-free lifestyle can be tough. What’s the best way to plan for a purchase when we’re used to looking at them in terms of monthly payments?
Try creating a sinking fund.
What is a Sinking Fund?
A sinking fund is a savings plan designed to help you pay cash for bigger ticket items. When you know you have a big purchase to make, saving a little bit at a time can take the strain off of your budget.
Let’s say you have a big purchase you plan on making six months from now. Simply take the total and divide it by 6. This is the amount you should set aside each month into a sinking fund. After the six months is over, you’ll have the cash on hand to make the purchase!
When Should I Use a Sinking Fund?
There are a lot of different things for which you can utilize a sinking fund. Try and think of things that reoccur every few months or every year that you know you have to pay for. These might include:
These things usually aren’t a surprise and should be planned for. By saving a little each month, you’ll be prepared when it’s time to make the payment.
Another area you may consider using a sinking fund is for a higher priced item that you want. This might include:
Down payment for a home
Computer or Phone
That’s right; you can use a sinking fund for a car. How awesome would it be to pay cash for your next vehicle? Simply pay yourself a car payment every month until you have enough to buy a new car in cash.
Where Should I Keep My Sinking Fund?
This is a common question. The answer? It depends on what the sinking fund is for.
For your smaller sinking funds, you can simply stick some cash in an envelope until you have enough money. Let’s say you are saving $100 for a gift for someone. It’s probably safe to stick this cash in a lock box or sock drawer at your house as you’re saving.
For the bigger ticket items, such as a car, you’ll probably want to open a savings account at a bank. There’s something about leaving thousands of dollars under your mattress that screams “disaster.”
Because many savings account charge a fee if you don't maintain a minimum balance, I recommend you only use it for the highest priced things. Ask yourself, “If something happened to this money, would it be disappointing or devastating?” If it would be financially devastating to lose that money, a savings account is probably the way to go.
Why Don’t More People Use Them?
Sinking funds are a fantastic way to stick to your budget while avoiding those big financial surprises. Even more importantly, they keep you out of debt.
So why don’t more people use them? The flaw of the sinking fund is it means you can’t have it right now. They take time to fill. Depending on the item your saving for, it may be months or years before you can afford it.
Being patient with certain purchases can be tough. Trust me, I’m with ya. I can spout out dozens of reasons why I should buy something right away, even when my heart knows I should wait. However, putting in the time and effort to save makes the purchase even more enjoyable.
Not to mention sinking funds have saved me from tons of mistakes. Had my wife and I ran out and financed a car a couple of years ago (before we had kids), we would have a small, fuel efficient car in our driveway right now. Luckily, since we took the time to save for a car, our needs have changed and adapted, and we were able to make a decision that will be more beneficial in the long run. The sinking fund bought us patience.
Before you can start using sinking funds, you need to have a budget. Budgeting is the foundation of finance. You can’t reach your financial goals without a detailed plan. Email me at firstname.lastname@example.org to sit down one-on-one so we can create a plan that works for you.
Your turn: What are some things you can start using a sinking fund to save for?