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Today, I’m going to teach you the basics of saving money for upcoming expenses, otherwise known as “sinking funds”.
I remember when I began my budgeting journey and would forget about those once-a-year expenses. The car registration fees, membership fees, car maintenance, vacations, and all other irregular expenses. This led me to use my credit card to cover those expenses and go further into debt. Once I learned how to save up for those expenses throughout the year, things changed. MY FINANCES CHANGED. I learned about sinking finds.
I’m going to get straight to the point and teach you the basics of sinking funds so that you can start saving money today.
What Are Sinking Funds?
Sinking funds are a type of savings account used to set aside money for a specific purpose. Unlike a traditional savings account that is expected to grow, a sinking fund is used to save for an expense that you expect to incur in the future. These funds are expected to be depleted, hence the term “sinking funds”.
When to Set Up a Sinking Fund
You should set up a sinking fund if you have an expense with a specific due date and a known cost. A sinking fund can be set up for small and larger expenses. For example, if you have a vacation planned, a sinking fund will help you to save money to pay for it. The same goes for setting up a sinking fund for medical expenses, as they often involve copays, prescriptions, and other costs. A car is a larger expense that you may not be able to pay all at once. Instead, create a savings account and put money into it regularly until you have enough to purchase the car.
How to Set Up a Sinking Fund
To set up a sinking fund, you need to know the total cost of the expense. For example, I plan to take a vacation in eight months. The vacation will cost $600, and the payment is due in six months. Next, decide if you want to save your money using a cash envelope or in a bank account. If you do plan to save money in a bank account, ensure that it is a separate account to avoid spending money from that account. There are plenty of free online bank accounts that you can use to create a sinking fund account. Once you have set up the cash envelope or savings account that you plan to put money into, it’s time to start saving!
How Much to Contribute Each Pay Period
Calculating how much money you need to contribute to the sinking fund each time that you are paid will depend on two factors. This will depend on how often you are paid and when the expense is due. If you are paid weekly, biweekly, or monthly you will use this to determine the amount that goes into your sinking fund each pay period.
For example, the $600 for the vacation is due in six months. I am paid biweekly (two times a month). There will be 12 pay periods before the vacation payment is due (6 months x 2 pay periods a month). The fund amount below will determine how much money I will need to contribute each pay period to reach my sinking fund goal of $600:
Fund Amount = Total Cost of Expense (Sinking Fund) / Total pay periods before the expense is due
Fund Amount = $600 (total cost)/ 12 (pay periods) = $50 per pay period
This example shows that I will have to contribute $50 per paycheck to reach my goal of $600 for vacation. You can use this same calculation for any sinking fund that you set up.
Key Takeaway
A sinking fund can be used to help you save for irregular expenses over time. It is money that you plan to spend, so it is not meant to be a long-term growth account. The best part about a sinking fund is that it is personal, and you can change it whenever you want to!
At this point, you have learned the basics of sinking funds and are prepared to set up your first fund. Before you do, please leave a comment below letting me know which sinking funds you plan to set up. This is your money, so start saving and make it fun!
