Archive for December 2015

How to use a sinking fund

At Christmas time, if you didn’t spend the previous 11 months of the year saving for the holiday, you might find yourself strapped for gift-giving cash. Previously, I shared how a sinking fund can help you financially prepare for recurring expenses throughout the year. If you read that article, you know what a sinking fund is.

But how do you use one and what makes if different from your other accounts?

Sinking fund vs. savings account

What’s the difference? A sinking fund is usually more specific than a savings account since you know how much you are going to put in there and when you will use it. A savings account could just be a place where you put money until you need it. Savings accounts could be used for the known, like retirement and home improvement/upgrades or the unknown, like emergencies and incidentals.

Where do you keep a sinking fund?

You want to have a sinking fund in a place where you can easily get to it. The bigger the amount, the more secure you want it. If you are saving $25 a month for four months so you can buy a birthday gift for someone, it’ll be okay to keep an envelope hidden somewhere in your home. Although, don’t be tempted to cheat and spend the money on late-night pizzas!

If you’re saving for a car, a simple savings account at the bank is probably a better idea. You can get to it easily and you don’t risk having a pile of cash lying around if someone breaks into your house. If you do this, make sure the account doesn’t have a minimum balance to maintain (such as a money market). You don’t want your money eaten away by fees.

With some patience and a plan, a lot of the cost and worry associated with big purchases can go away. You’ll prevent credit card interest rates and fees as well as reduce the stress that comes with larger purchases. Don’t let these expenses sneak up on you, plan and prepare for them.

What is a sinking fund?

Christmas comes on the same day every year. And yet when we’re sitting around the Thanksgiving table, we suddenly realize we haven’t saved a dime for the gift giving extravaganza. Every Black Friday we go crawling back to those high interest credit cards in an effort to give our friends and family the “perfect” Christmas.

All year long we encounter expenses we know are coming but do nothing to prepare for them. Why run your household spending plan like that? Car insurance, birthdays and many other recurring expenses can all be budgeted for and handled months in advance with sinking funds. It’s not complicated, and you can start right away.

What is a sinking fund?

A sinking fund is a reserve of money set aside for a specific purpose. It can best be described as a pool of money that is set aside to cover future payments. Think of it as a piggy bank that you put money into and when the time comes you get to smash the little piggy and use the money you’ve been saving. Sinking funds can be used for all sorts of expenses; taxes, insurance, big-ticket items, and even utilities.

With a sinking fund, you save a small amount each month for a certain amount of time before you make your purchase. You determine how much you save by taking the total amount to be spent and dividing it by the number of months you have left until you must pay. For example, if you want to spend $1,000 on Christmas and it’s April, that leaves you about eight months to save. Just put a line item into your budget that you want to stash away $125 per month until December.

Who uses sinking funds?

Sinking funds are commonly used by businesses and government agencies. My business uses tax software that costs $19,000 annually. So, I make “payments” to a designated bank account each month of $1,500. When my annual invoice arrives, I have the money I need set aside. This practice should be part of a healthy personal budget as well.

If you think of your family as a company that you’ve been assigned to manage, it would only make sense to make sure you have funds readily available for the many things that surface in any given year.

You can do this with any major purchase or bill. If the cost for car insurance is $500 every six months, then save $83 a month as soon as you pay for the latest insurance coverage. If we get into February and you want to spend $50 or $75 on someone who is going to graduate from high school or college in the spring, then set 15 or 20 bucks aside each month until the big day.

I’m a big advocate for sinking funds in anyone’s personal or business finances.