Saving money wisely requires not only discipline, but also strategic thinking. It’s not enough to put aside a sum of money once a month, because you have to take into consideration that every month is different and there are some months where you don’t have any major expenses, but there are also some where you spend more than you do in a whole year (recall how much Christmas holidays cost you, when you not only have to prepare dishes and decorate the house, but also buy gifts). Sinking funds may help you with being prepared for that.
If you are serious about your finances, you should take into account that once in a while bigger expenses happen to you and you are already able to anticipate them, such as holidays, birthdays of loved ones, car insurance, etc.
Skinking fund method is a way of saving money for larger expected or planned expenses that you are not able to cover at once from your paycheck. In other words, you know you have a big expense coming up, so you start saving in advance. Most people sometimes use the sinking fund method unconsciously, especially when it comes to saving for a vacation. They know they are going on a well-deserved vacation in a few months, so they start saving for it in advance. But sinking fund can be used for various expenses.
WHAT TO USE SINKING FUND FOR?
- gifts for birthdays/holidays
- vacations
- car expenses
- home renovations
- fees for college
- health checkups and doctor visits
- family celebrations
- house deposit
- wedding
The truth is that you can create as many sinking funds as you need, for both small and big expenses that you assume that will occur in the future (in the next free months, next year or even in a few years). It’s completely up to you.
HOW TO CREATE SINKING FUND?
The sinking fund method is quite simple and you can use it whether you are running a budget or not. Here are some simple steps on how to plan a sinking fund.
- Identify the purpose. It can be an expense you are planning (vacation) or one you are forced to incur (such as car insurance). You can specify any number of such expenses. Let’s assume that your goal is a vacation and a wedding.
- Determine how much you will have to spend on your goal. You anticipate that the vacation will cost $2,000 and the wedding will cost $35,000.
- Determine how much time you have left to spend, e.g. you want to fly on vacation in August, so you have 7 months left, and your wedding expenses will occur around July 2023 (you have 18 months left).
- Determine how much you need to save per month – to save the amounts for these expenses by the time they occur. Since you need to raise $2,000 in 7 months for the vacation, you need to save about $286 per month ($2,000/7), and $1945 per month ($35,000/18) for the wedding.
- Done! Now all you have to do is put aside the set amounts every month. To make this task easier, you can use a simple “sinking fund tracker”, which you can download for FREE – >click here.
WHERE CAN YOU KEEP SINKING FUNDS?
It all depends on how much time you have left to save the moeny. If it’s only a few months or so, then take advantage of a well-interested savings account, so your money won’t lose as much of its value.
However, if you are saving a larger amount and on a long-term basis-for example, for the purchase of a house-it is worth considering other methods of storing your money that will effectively protect it from inflation. The best thing to do is to look for information on this subject from trusted bloggers from your country, as it may look different in each country, for example, in my country a safe option for investing money (better than a savings account) are treasury bonds (but not all of them).
The way you keep your sinking fund savings is up to you: you can keep them together in one place (in one account or in one envelope) or create separate accounts (or use many envelopes). A recommended method of storing money within a sinking fund is the cash envelope method, which involves allocating a separate envelope for each goal, into which you set aside a set amount of money each month.
WHAT DOES SAVING WITH THE SINKING FUND METHOD GIVE YOU?
- teaches you self-discipline and better organization
- you don’t have to borrow money if any expense exceeds your monthly budget
- you have more control over large expenses
- you don’t worry that an expense will surprise you
SINKING FUND VS EMERGENCY FUND
As I mentioned earlier, a sinking fund is saving small amounts at set intervals to cover a larger expected expense. An emergency fund, on the other hand, is a fund in which you save money for situations you can’t foresee, such as job loss, illness, loss of a car, unforeseen home repairs (because your bathroom flooded, for example), etc.
Both methods are meant to protect you from a situation in which you are forced to borrow money from someone else and incur interest costs later.
As you can see for yourself, the sinking fund method has only advantages and practically zero disadvantages, plus it’s an easy way to start consciously saving money and not get into debt.
