When you hear the words "sinking fund," you might think of a pirate ship that goes down with a lot of gold on board. Well, it's a little different in the world of finance but the benefits can be the same! Read on to find out why sinking funds are best when you know you have a big expense coming up.
Have you heard of a "sinking fund"? A sinking fund is a sum of money you set aside (usually by saving a little bit each month) that is not part of your savings account or emergency fund. You can use a sinking fund to pay for home repairs, car repairs, save up for a new car, pay for a trip, or pay for big medical bills. By putting the money away before you spend it, you won't use your emergency fund when you don't need to.
Plus, when it's time to buy something, you'll be able to get a better deal. Some businesses also call planned expenses "sinking funds." A sinking fund is a great financial safety net for your personal finances. It helps you avoid debt, stick to your budget, and reach your financial goals.
- Buying or financing a vehicle
- Car repairs or maintenance
- Fixing or remodeling a house
- Insurance premiums
- Buying new furniture
- Saving up for a trip
- Gifts for the holidays and trips
- Paying taxes for self-employment
- Attending a wedding or throwing a baby shower
- Living expenses during parental leave
- *insert favorite band* concert tickets!
You can use your sinking funds for a number of different things. You can set up a sinking fund for a planned expense (like a vacation) or an annual expense. Sinking funds could be used to pay for things like a trip, home improvements, or taxes. Set up a sinking fund for a big expense, even if you don't know exactly how much it will cost.
Sinking funds work best when you know you need to pay for something in the near future, give it a due date, and include it in your budget. They are not connected to your emergency fund or other savings accounts in any way.
When you set up a sinking fund, you'll have to decide how much money to put into it. Then, divide that amount by the number of months until you make the purchase or expect the expense. Lastly, you add these amounts to your budget to make sure you have enough money to pay all of your monthly bills and save for emergencies.
If your sinking fund is for something like a car repair or medical bills, you may have to decide how much you want in the fund even if you don't know how much it will cost. You can put the money away until you have enough. Once the money in the fund is gone, you can add more as needed.
Your sinking savings should be kept in relatively liquid accounts. A money market account with a high interest rate is a smart move.
What you want to do with the fund will also influence the sort of account you select. You might be able to invest the funds in a less accessible account with a greater yield if you are working toward a longer-term objective that will take many months or years to complete. Consider putting your sinking funds in a savings account that pays a greater interest rate than your local bank if you want to increase the interest you receive on them. You can decide to have different sinking fund savings accounts. For instance, repairs and maintenance could occur at any time, therefore the money needs to be available right away. Since you will be aware of when you will need the money, your down payment for a property does not need to be as liquid. As a result, you might be able to increase the rate of return on the money you are accumulating.
You should plan a monthly transfer, just as your employer can deduct money from each paycheck to put into your 401(k). Organizing your money to take care of regular contributions for you is the simplest method to develop the habit. This recurrent payment may be little if you don't have much money left over. Then you can use your extra money to make one-time transactions at the end of each month.
Well with a savings account, you are working towards growing your wealth. As you save more and more money, it will start to work for you at some point. You don't want to put your hand in it.
With a sinking fund, on the other hand, you save money for a planned expense. This means that the money was always meant to be spent. A sinking fund isn't likely to add to your overall net worth, but it can help you do things like buy a new fridge, go on a family vacation, putting a down payment on a house or preparing for Christmas.
Sinking funds are made for expenses that are already planned. For example, you could use it to pay for a known cost, like replacing your kitchen floor. A vacation is another planned cost. Or for example, any of the annual costs you currently have, you can prepare for them with sinking funds. If you know you need new glasses every year, you can plan for them.
But your emergency fund would pay for a home repair that came up out of the blue, while you would use a sinking fund to pay for the expected Christmas house decorations that you have fun doing each year.
You might be good at saving money for emergencies or sticking to a monthly budget. But learning about sinking funds can help you manage your money better and stay focused on your financial goals.
You realize the impact that smart financial planning can have? The most important quality you'll need is patience. And a budget! We are a culture of instant gratification. Today we bring something home. Anything that takes more than two days to delivery has become illegal thanks to Amazon. But do you know what you won't have if you have patience and a plan? Worry. Starting some sinking money now will help you avoid stress in the future.
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