The term sinking funds is used a lot, particularly when it comes to budgeting or when aiming to become Debt Free. So, what are sinking funds?
What are Sinking Funds?
A sinking fund is the regular saving of money in preparation for paying for something by a certain date. By breaking down the total amount into smaller weekly or monthly amounts, you can ensure that you have money ready to pay for bills, for Christmas, for car repairs, for holidays - basically whatever you need to save for you can save using the sinking funds method.
Sinking funds can even be used to save for an unknown or variable amount. An example of this would be white goods. You don’t know what will need replacing or when it will need replacing but inevitably something will break down and you will either need to have it repaired or replaced.
Your emergency fund could be used for this especially if that is one of the purposes you identified. Alternatively you could put an amount of money away each month and let it build up. I save £10 per month, every month and only spend this when something breaks down.
What is the purpose of a Sinking Fund?
Sinking funds are a fantastic way to help you budget long term. You know you need £x for food and petrol each month, but using sinking funds in your budget will help you put small amounts away for the one off payments, annual payments or a bigger savings goal..
They're a great way to save for your future too. If you are planning to move house, travel the world or get married, start a Sinking Fund.
Sinking funds are a key aspect of budgeting and becoming debt free. Easy to start and with a little bit of planning, they allow you the breathing space that is needed when you are trying to manage your money.
Sinking Funds Examples
- Car Tax
- Car repairs
The list is endless. You can apply the sinking funds method to regular or one-off payments. It’s all about trying to save little and often to be able to pay upfront for the things you need, which in turn will prevent you getting into debt.
You can apply this to any money goal including ones where you don’t necessarily have a target date. Having been caught out one too many times, I began a sinking fund for school trips. I never know when they will take place or how much they will cost until that letter arrives home, so I just put a fixed amount of money away each month and let it build up.
Sinking funds can even save you money. Imagine using a sinking fund to save for your house or car insurance each year. This will allow you to take advantage of discounts for paying the amount in full because you will have the money sitting in your account.
A Sinking Fund is not an Emergency Fund
Don’t get these two mixed up. Your emergency fund is savings which are to be used for emergencies only, whereas your sinking funds are meant to be spent on the expense that you have identified.
How to start a Sinking Fund?
Pick an expected expense. This could be an occasion like Christmas or a birthday, or an upcoming bill like your car insurance.
Let’s take Christmas. This happens at the same time every year. If you would normally spend £500 on Christmas presents and you start your sinking fund in January. By dividing the £500 by 12 months, you can see that if you need to save £41.66 per month and you will have your Christmas present money ready in time for Christmas and won’t need to try and find it out of that month’s pay packet or use your credit card (you could still use your credit card but you will be able to pay the bill off in full).
You can start with an annual bill like your car insurance. Take the full amount and divide this by 12 if you get paid monthly (or by 52 for weekly). If your car insurance renewal is £300, then the amount you need to budget for and add to your car insurance sinking fund is £25 each month.
Where should I save my Sinking Fund money?
There are some fantastic bank accounts around that allow you to set different categories up. These are ideal for managing your sinking funds.
My current account is where my monthly expenses are paid from. My sinking funds are in a separate account to my current account. I use a spreadsheet, which I update each month after payday. This has a column for each sinking fund and I can see, at a glance, how much money I have in each category.
Do you have sinking funds, or are you planning to start one?