Find Out When to Use Sinking Funds and How Much You Should Have Saved
Now that you’ve made a budget, it’s time to add in a very important component: Sinking Funds. In this post I’ll explain exactly what sinking funds are, and talk about why every budget absolutely needs them. As in, your budget will almost certainly fail without them. I’d say that’s pretty essential! So let’s dive in.
What Are Sinking Funds?
In a nutshell, a sinking funds is money set aside for big things that you know will eventually come up. This can be a wide range of things. Everything from events that you know happen every year (like car registration) to stuff that’s unexpected but inevitable (like a vet bill).
Ideally, this money should be set aside in a separate account, or accounts if you like to make things complicated, but still be readily accessible. Depending on how much self control you have, this can be a linked savings account at your primary bank, or tucked away just far enough to be out of mind in an account you rarely look at.
EveryDollar suggests that you have three sinking fund categories: Large purchases, overlooked expenses, and unexpected events. If you contribute to sinking funds in these three areas, you should be well covered for anything that comes up.
Sinking Funds vs. Emergency Funds
Don’t make the mistake of thinking your sinking funds are your emergency funds. They shouldn’t be the same thing, though they are similar and have some overlap.
While your sinking funds can help you in a small immediate emergency, like a car repair, in a perfect world you’d aim to have two separate funds. The emergency fund is intended to support you in ALL of your expenses for about 3-6 months, should you lose your job.
That means this is probably a much larger account and you want to keep that separate and as untouched as possible. The sinking funds are by definition funds that you plan to pull from periodically throughout the year.
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How to Start A Sinking Fund
For these reasons, in my opinion you should incorporate a sinking fund into your budget long BEFORE you start working on anything else. As in, immediately after you’ve determined your monthly expenses and income.
Yes – even before contributing more to a retirement account or paying extra towards debt! It should be another line item in your budget. If you can’t set aside a pile of cash to cover what you’ll need all at once, then you’ll need to pay it like a bill until you have enough.
Otherwise, while you’re budgeting through your monthly expenses, it may take a while to save enough in your sinking fund. And you will inevitably have some annual expense come up that will throw off everything.
If you don’t have that expense worked into a long term, big picture budget via these sinking funds you’ll end up putting it on credit or pausing your emergency fund savings anyway. All of that can get discouraging, so do yourself a favor and work in a sinking fund first in your budget.
How Much Should Be In A Sinking Fund?
Of course, when you set one up and how much you designate is entirely up to you and dependent upon your individual situation. You’ll need to look at your annual expenses as a whole, and consider all areas of your life.
For example if you have kids and/or pets that will need to go to the doctor, work that in. If your car is 10 years old, incorporate some cash for repairs. Home maintenance, taxes, work expenses, memberships, gifts. You should evaluate it all together and determine what you need to include. Think ahead, determine what’s coming up first, and start with that. Then incorporate the rest as you decide.
Final Thoughts on Sinking Funds
Everyone’s budget and requirements will be different, but the important part is to step back and take a big picture view of your finances. Going month to month is great to start a budget, but past that you will absolutely need a plan for those inevitable other expenses.
Think about your annual costs. Though you might not be able to remember them all at first, when they do come up, record them somewhere you can refer back to and prepare for them to come around the next time.
That’s about it for sinking funds. Do you have any thoughts on this crucial component of a budget? Let me know in the comments and tell me what you include in your sinking funds. Happy saving!
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