Have you ever had one of those months where you’re right on track with your budget and feeling really proud of yourself, and then your car breaks down?
You’ve got a $500+ expense that you hadn’t planned for, meaning you have to put it on your credit card. Now, instead of spending the next few months saving up for that weekend getaway you’ve been dreaming up, you’re going to spend it paying off those car repairs.
Luckily, there’s an incredibly simple solution to prevent this problem from happening again: Sinking funds.
In this post, I’m going to share what sinking funds are, why you need them in your budget, and how to get started using them today.
Sinking Funds: What They Are and Why You Need Them in Your Budget
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What is a sinking fund?
A sinking fund is a savings strategy you can use to save monthly for planned expenses that come up throughout the year.
The entire concept of sinking funds is that you save a bit of money each month for big expenses you know you’ll only have to pay once in a while.
Let’s say you spend $600 each year on Christmas. Rather than waiting until the end of the year and having that oh shit moment when you realize how much you’re spending (end ultimately putting it on a credit card), you can save throughout the year. Set aside $50 per month for Christmas, and when December rolls around, you’ll have your entire $600.
Sinking funds are effective for three different types of purchases. The first type of purchase is expected costs that you know how much will cost. Examples of this include vehicle registration, insurance, and annual subscriptions.
Sinking funds are also ideal for expenses that you know are coming, but that you don’t know quite how much they’ll cost. These expenses include car repairs, medical bills, and pet expenses.
The final type of expense you can use sinking funds for is saving for financial goals. If you’re saving up for a vacation or the downpayment on a home, you can use sinking funds by setting aside a specific amount of money each month.
The important thing you have to remember is to treat your sinking funds just like any other bill — Nonnegotiable.
Why are sinking funds important?
There are so many expenses that pop up throughout the course of the year that we know are coming, but that somehow always seem to catch us by surprise. And they always end up screwing your budget.
Sinking funds allow you to spread those expenses out across each month, instead of paying them in a lump sum when they pop up. That way, you can ensure you’re never going over budget.
You’ll never have to feel guilty about going on that vacation or spending money on the holidays, because you’ve been planning and saving for those expenses.
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Common sinking fund categories
Everyone’s sinking fund categories are going to look a bit different based on what you’ve got going on in your life, but here are some common sinking fund categories:
- Vehicle registration
- Car repairs
- Car insurance
- Home repairs
- Medical bills
- Pet expenses
- House downpayment
- Association dues
- Car replacement
- Kid-related expenses
- Annual subscriptions
- New appliances
How much should I put in a sinking fund?
Each sinking fund is going to have a different amount in it based on how much you expect to spend in each category.
For fixed expenses, this will be easy. Let’s say you’re creating a sinking fund for your vehicle registration, which costs $120 per year. Save $10 per month, and you’ll have the full amount after one year to pay for your vehicle registration.
For variable expenses, you’ll have to estimate how much is appropriate for you. One way to do this is to look at how much you’ve spent in the past.
Let’s say you’re setting up your Christmas sinking fund. Look back in your budget to see how much you spent on Christmas last year, and you’ll have a good idea of how much to save.
Where should you keep your sinking funds?
When it comes to storing and keeping track of the money for your sinking funds, you have a few different options.
I’ll start with my favorite: You Need a Budget (YNAB). YNAB is a budgeting app that allows you to not only plan your monthly budget, but to plan your finances further into the future, and track the money you’ve set aside for specific purposes.
At any given time I can see exactly how much money I have in my pet expense sinking fund, for example. Then, when I spend money on our dog, it gets categorized as a pet expense in YNAB. The money that I’ve set aside for each category just sits in my savings account until I need it.
YNAB is hands-down my favorite budgeting app and has totally transformed our budget. It has an annual fee, but you can grab a free trial here.
If you’re not using a budgeting app like YBAB to track your money, I recommend using a savings account with budgets (or just multiple savings accounts) to separate your sinking funds.
In addition to the savings account I have at my credit union, I also have a savings account at Ally Bank. Ally Bank allows you to use buckets in your account to separate the money you’re saving for different purposes.
What is the difference between a sinking fund and an emergency fund?
You might be reading this post and wondering what the difference is between a sinking fund and an emergency fund. After all, aren’t they both just a way to save for emergencies?
An emergency fund is a way to save for unexpected emergencies. The most important job of your emergency fund is to temporarily cover your monthly expenses in case you lose your job. That’s why it’s wise to have 3-6 months of living expenses in your emergency fund.
Learn more here about how to build an emergency fund and how much you should save.
A sinking fund, on the other hand, is for specific expected costs. In some cases, it will be a cost such as your vehicle registration or your Amazon Prime membership where you know exactly how much it costs.
Others, such as car repairs, you don’t know exactly how much they’ll cost, but you know they’ll come up eventually. If the amount you need exceeds the amount you’ve saved, then you can dip into your emergency fund to fill the gap.
I can totally relate to that frustration of getting hit with an unexpected expense, or an expense that you knew was coming, but totally forgot about.
I can honestly say that sinking funds have completely changed my finances around. Rather than getting hit by expenses that I have to throw on a credit card, I’m able to plan ahead with my budget and instead put my money toward things I’m really excited about (rather than those pesky car repairs).