Your washer breaks down and you need a new one. Or in my case, the furnace is near the end of it’s life and you need to replace it soon. A brand new furnace can run anywhere from $600 to $2,000.
How would you handle the extra but necessary expense? Instead of using a credit card or borrowing money from others, you can establish sinking funds to help cover the costs.
What Are Sinking Funds?
A sinking fund is a fund formed by periodically setting aside money for the gradual repayment of a debt or replacing of a wasting asset. In other words, you can have one of more sinking funds. Each one represents a savings bucket for a specific planned expense.
Many people confuse sinking funds with emergency funds or believe you only need to have one emergency savings account. Here are a few reasons why you should abandon that thinking and start adding sinking funds to your financial plan.
It’s Not the Same as an Emergency Fund
Having a sinking fund is not the same as having an emergency fund. If you’re using both accounts interchangeably, you’re doing it wrong. An emergency fund can provide financial relief in the event of an unexpected event or emergency.
Let’s say you have a medical emergency and can’t return to work for a few days. Or, you lose your job with no notice. These are true emergencies and expenses you had no idea would occur.
You can’t prepare for them specifically since you don’t know they’re happening. You can only start stashing away money to cover any unexpected expense when it pops up.
With sinking funds, you’re saving up money for planned expenses. You know the expense is coming up but it can still take you by surprise and ruin your budget if you don’t prepare accordingly.
Some people use sinking funds to save for Christmas, new furniture, a new car, birthdays, etc. When you don’t set up sinking funds to cover these expenses, they can often seem like emergencies when they occur since you don’t have the money on hand and need to come up with it quickly.
This is why it’s best to have both an emergency fund and sinking funds so you can cover all your bases.
Become More Prepared For the Expected
We now know that sinking funds allow you to become more prepared for the expected. Let’s go into more detail on how this helps you. You probably already have some type of budget or spending plan for your money.
Your first step with developing a sinking fund is acknowledging the planned expense. Then, you’ll determine how much you need and when you’d like to have the money saved. Coming up with a clear plan helps you budget more efficiently. You can now develop a savings category for the sinking fund and budget for it monthly.
By being prepared for the expected, you’ll avoid drawbacks like paying late fees or even losing benefits like insurance for example. Plus, it won’t throw off your budget severely.
For example, both my husband and I have cars that need new registration stickers each year. They are $100 each and mine is due in April while his is due in May. Without it, we’d risk getting a ticket or paying a penalty for getting our stickers late.
We decided to develop a sinking fund for this expense because $200 of extra expenses could easily throw our budget off in the spring. We’d only have to set a small amount of money aside each month for the year, but this easy preparation would pay off when our registration is due.
Avoid Having to Borrow Money or Take Out Loans
Another reason why you should add sinking funds to your financial plan is to avoid debt. Using credit cards or loans to serve as an emergency fund or sinking fund is not acceptable and will only provide temporary relief.
When you think about it, using a credit card or taking out a loan to pay for an expense you can’t afford means you don’t have the money in the first place. How will you then manage to pay back the money plus interest? You can clearly see that borrowing money you can’t really afford to repay just puts you deeper int he hole.
I can’t even mention enough how great it feels to be able to pay for Christmas in cash as we’ve been able to do the past few years. The same goes with being able to pay for our wedding in cash along with birthday parties for our son.
Having the money you need on hand helps you avoid unwanted debt. In turn, you have the opportunity to get ahead faster.
You’re Probably Already Using Sinking Funds
Let’s face it. Sinking funds are nothing new. In fact, you’re probably already using them in one capacity or another and just don’t realize it. Have you ever saved up for a vacation? Many of us have and this is an example of using a sinking fund.
You see, you’re already planning to set aside money for planned expenses even though they may be for fun or leisure activities. Maybe you have a concert for your favorite recording artist coming up and start to plan out your paychecks over the next few weeks.
Why not formalize this method of financial planning and establish a few core sinking funds to help you plan for other expenses? You can create sinking funds for any planned expense that you’d rather start saving for in advance.
I have sinking funds for
- House maintenance
- Car maintenance and a new car
- Our car registration
I’d recommend starting with 1-3 core sinking fund categories. That way, you don’t spread yourself too thin. Consider opening an online savings account that will allow you to open several connected accounts for free. I like CapitalOne 360 because they have no fees and you can open up to 25 different savings accounts and nickname them for free.
Have you ever thought about using sinking funds? Which one of these benefits would best serve you?