Learn what sinking funds are and what they are not. Plus, learn when they are appropriate and when they are not, and how to set one up.
Picture it: you’ve built an Undetailed Budget and it’s working great. But, you know that someday soon you’re going to need to buy something that costs more than your discretionary spending in a month. What should you do?
Well, if you want to be normal, you can just borrow the money. But, as you know, I believe that if you can afford payments, you can afford to save up. But how?
For me, the best approach is to use sinking funds.
What are Sinking Funds
A sinking fund is a temporary savings bucket that you pour money into over time for a specific future purchase. You put money into it every month before you make your purchase. Then, you use the accumulated savings to buy whatever you need.
A sinking fund is not an emergency fund. You need a separate emergency fund.
Also, a sinking fund is not an investment. Investing requires at least 5 years. Sinking funds are generally for purchases that are a few months to a few years away.
When to Use Sinking Funds
If you have a large purchase coming up that will cost more than your monthly discretionary spending, then you will need a sinking fund.
Great examples of sinking funds include saving up for a computer, vacation, Christmas, a new furnace, home improvements, or vehicle purchase.
To get started, figure out how much you will need and when you will need it. Then, divide the cost by the number of months until then. Set that amount aside in a savings account every month.
How to Set Up Sinking Funds
At any given time, I have 3 to 10 sinking funds that I’m working on. But, I don’t want to open a separate savings account every time I need a new one. That would drive me and my bank crazy.
In the past, I have used Excel spreadsheets to track my savings goals. I would have one savings account and I would track what the balance was intended for in Excel.
I’m a huge Excel nerd, and I know that’s not for everyone.
Happily, banks have started building this functionality into their savings accounts. Personally, I use the online bank Ally. They allow you to create “savings buckets” inside your account, which is exactly the same thing.
Double-check if your bank allows you to build savings buckets in your online portal. If not, consider changing where you keep your savings. There are a lot of great high-yield online savings account options with some great functionality.
People who Don’t Need Sinking Funds
I’m a huge finance nerd. I like spreadsheets and organization.
And, I also like to know that I’m putting my money to work appropriately. I don’t like to have too much or too little in savings.
If I have too much in savings, that means I have money sitting on the sidelines that could be invested. On the other hand, if I have too little in savings, I run the risk of having to use debt or push off important purchases.
As a result, sinking funds are perfect for me.
But, if you are the kind of person who likes to have a bigger savings cushion, then sinking funds may not be necessary for you. People who don’t need sinking funds get peace from having $10k-$50k in a savings account beyond their emergency fund. That way they can dip into that for large purchases.
It is totally up to you! The most important thing is that you develop the habit of using your own money to pay for large purchases. We all need to break up with our credit cards, store credit, and personal loans.
It is way too easy to reach for the credit card any time we want to make a big purchase. Don’t spend another dime of your hard-earned money on interest because you weren’t willing to get organized.
It is time to stop the cycle. Take control of your finances and never buy anything again unless you have the money to pay for it up front (with exceptions for housing, and maybe education and cars).
Plus, with all of the online tools available, it has never been easier to get a handle on your finances. You don’t even have to use Excel!
What to Read Next
For more information, check out these articles that offer more detail about these topics. Enjoy!
- The Undetailed Budget
- If You Are Willing to Pay Over Time, Why Are You Not Willing To Save Up?
- Only Use Debt For Real Estate, School, and Cars. Nothing Else
- The Four Pillars of Personal Finance
I hope this has been helpful! I welcome your comments with your thoughts and questions. And, don’t forget to subscribe to the newsletter to get notified whenever a new article is posted.