In sharing my financial journey and advice, I’ve talked about saving money in emergency savings for unknown, unexpected expenses that happen in life.
While saving money in an emergency account should be a priority, my #1 budget tip for 2020 is saving for infrequent but planned expenses in what is known as “Sinking Funds.” I am a huge fan of sinking funds because they allow you to save, save, save, then pay for that NEED or WANT in cash.
How Sinking Funds Work
The central concept of a sinking fund is that you set aside a specific amount of money each month for a certain amount of time for something in particular. It can be saving for:
Holiday Gifts
License Plate Renewal
Life Insurance Premiums
Vacations
A New Car
Phone Replacement
Auto Insurance Premiums
Taxes
Annual Membership Renewals
Children’s Back To School Purchases
Renters/Homeowner’s Insurance Premiums
Professional Certification Renewals. And the list goes on and on!
Also, it could be considered a line item expense on your budget each pay period to help you prepare and track for something that may be months or years away. By setting up an expense category on your budget and title it, “Sinking Funds,” you’ll know the monthly amount you need to set aside for each sinking fund, which will allow you to save cash for a potentially large purchase.
Let’s say you are ten months away from going on a cruise, or twenty paychecks away. You also know you’ll need $1,000 to pay the balance for the cruise two months before the journey.
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You’ll have 16 paychecks (8 months) to save up $1,000. Saving for your cruise will be $62.50 per pay period, and your budget will have a new line item, listed as a “Cruise Sinking Fund,” $62.50 per pay period.
$1,000 ÷ 16 = $62.50 per pay period
The idea is that when the time comes to pay for your cruise, you have all of the cash you need to pay for it. Your cruise sinking fund prevents you from being forced to finance the trip on your credit card, and then carry the balance from month to month.
Here’s another example:
Having a “Home Repair Sinking Fund” is a smart move for any homeowner because homeowners know that repairs and ongoing maintenance can be costly to fix and to replace.
HomeAdvisor reports that the average homeowner spends an average of $1,105 per year on maintenance. Using this figure, you would divide $1,105 by the number of pay periods in a year.
Let’s say you get paid biweekly for a total of 26 pay periods per year. Putting aside $42.50 per pay period will give you $1,105 within a year.
$1,105 ÷ 26 = $42.50 per pay period
Little by little, you add to your home repair sinking fund, and as months pass before you know it, you’ve saved enough to pay for the cost of repairs or for the cost of replacing a major appliance without having to put it on credit.
Sinking funds not only prepare you for predictable expenses that do not occur every month, but they also help you plan your budget for the long term.
Where To Keep Your Sinking Funds
The best place to safely keep your sinking funds is in a traditional savings account at a local or online bank or credit union, as these funds are not investments, and you generally do not earn more on your savings. Also, your sinking funds should be completely separate from your emergency savings fund.
Some banks and credit unions offer a “savings club” or other programs that allow you to set up multiple savings accounts at no additional charge and earmark the funds for a goal-oriented purpose. Also, setting up your sinking funds through an automatic transfer from your checking account into your savings, each payday will keep you on track. Once you reach your goal, then put the transfer on pause until you use the money in the fund. After using the money, you can replenish it as needed.
You can save money in so many ways when you prepare for future expenses, and sinking funds are a great way to budget and save money!
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Livia Kelly is the Author of Unmarried and Debt-Free. Livia's book has made Amazon's #1 Best Seller list in Personal Budgeting and Two-Hour Self-Help Short Reads. Her goal is to simplify finance by providing sound and useful guidance about budgeting, saving, tackling debt, and achieving financial success on your own. More information can be found at https://www.liviakellyauthor.com.