If you’re new to the world of budgeting and personal finance you’ve probably come across all kinds of terms that you’re a bit unsure of – a term that stumps a lot of people is ‘Sinking Funds’ and since it’s one of my favourite money ideas/concepts I thought we’d delve into it a bit more today and I’ll explain exactly what sinking funds are, how to utilise them and how they can revolutionise your budget.
What is a Sinking Fund?
A Sinking Fund is a type of strategic savings pot where you put aside a set amount of money each month towards a specific goal. Sinking Funds are designated savings pots for planned or predicted expenses, by anticipating and planning for these expenses and spreading the cost over a longer period of time it makes much less of a dent in our budgets month to month.
Sinking funds help us to not only plan for the future, be that a planned ‘want’ of something like home renovations or an unplanned ‘need’ to replace a tyre on the car, but they also help to lose any guilt associated with large purchases – if you’ve set a goal to save up for a certain big purchase and have saved for it over time, then when it comes to buying that item, there is no stress or worry because you know you have the money sitting there ready to be used.
…Why is it called a Sinking Fund?
There are two answers to this – traditionally, if we were talking from a strict financial/banking POV a sinking fund is ‘a fund established by an economic entity by setting aside revenue over a period of time to fund a future capital expense, or repayment of a long-term debt’
But in the debt-free community, it’s generally accepted that it’s called a ‘sinking fund’ because when you have them it stops random unexpected expenses ‘sinking’ your budget!
Why you need Sinking Funds
Why do we need sinking funds? Well, to put it plainly, Life happens!
Notice we didn’t say sh!t happens, it’s important to realise there are two sides as to why we do this strategic saving – sinking funds aren’t only there to cover bad expenses they help us with the good expenses too.
The Good – Weddings/Babys/Home Renovations/Holidays
We know by now that ‘budget’ isn’t a dirty word and having a budget actually gives us permission to spend money, so you can think of Sinking Funds as giving you encouragement to spend money, the only catch is that you have to have saved it up first!
The Bad – Car Problems/Broken White Goods/Home Repairs
Most of us know the phrase “if something can go wrong, it will go wrong” (you might know it as Sods Law or Murphys Law) and that is never more true than when we are getting on top of our finances, it usually feels like the universes way of restoring balance – you might finish paying off a credit card and then the engine light flashes up on the car dashboard.
The different type of sinking funds you should have
There are no hard and fast rules on this, as with everything in personal finance – it’s personal so it’s completely up to you but the general school of through is that there are 3 different categories of sinking funds that will cover almost every eventuality.
Large Longer-Term Planned Purchases – This is probably the most commonly used type of sinking fund and it would be used to save for things that you know are coming up but are more expensive and further in the future such as home renovations, new car, a wedding, holiday.
Anticipated Yearly Budget Items – There are certain things that happen each year (Christmas, Birthdays, Car MOTs) that can add up to be pretty expensive but if we use sinking funds to save up towards them and spread the cost across the year it makes them much more manageable. Did you know that it’s sometimes cheaper to pay for certain things like car or home insurance yearly than it is monthly? If you can manage to set up a sinking fund for things such as insurances you can sometimes save up to 20% off of the price by using your sinking fund to pay for the year upfront.
Smaller Miscellaneous Purchases – These type of sinking funds can be incredibly helpful when it comes to budgeting as it covers the sort of things that can really bust your budget month to month if you haven’t pre-planned. You’d use these to save up for things like school uniforms for the new terms, seasonal clothes, vets visits.