Guest Author: Maia Fletcher
Sinking funds are a great tool to get your life on track. Money doesn’t come easy, and debt can, unfortunately, be easy to come by. Over time, the interest earned on debt can become a nerve-racking expense hanging over your head.
This is where sinking funds can come into play. A sinking fund is essentially a strategic way to keep you out of debt. These self-created funds work by setting aside money each month towards a specific financial expense. As a result, you’ll be able to create a separate pool of money from your savings or normal emergency account that you can use for a different specified purpose.
What are sinking funds used for?
Sinking funds can be used for any purchase. Many people opt for a sinking fund when making a significant, planned purchase. Examples include household furniture, annual tuition fees, or a new car.
For example, vacations are usually planned in advance rather than booked last minute. A sinking fund is the perfect strategy for saving for your dream holiday! Although you may not know the exact cost of your holiday until you go, a sinking fund could be used to prepare for the costs of activities and food ahead of time. An estimation will help to cover a significant part of your expenses upfront. Medical bills, hosting an event, home renovations, and self-employment tax are also all great use-cases for creating a sinking fund.
What type of people should have a sinking fund?
Anyone can start a sinking fund. In a nutshell, sinking funds work best for people who are making a large purchase that is not part of their usual budget, or for people who are struggling to save. Putting aside money for a specific purpose in an account separate from your savings further will further bolster your ability to pay off the purchase.
Before starting a sinking fund, include your partner in your discussions regarding money matters.
How do I set up a sinking fund?
Firstly, choose the reason for starting your sinking fund. It’s okay to have multiple sinking funds to cover different expenses at the same time, as long as it works in conjuction with your budget.
Next, estimate the total amount you would like to allocate towards the fund. Then, decide the number of months you intend to save for to reach the cost of the purchase. Divide the total cost of the purchase by the number of months, equating to the amount required for your sinking fund each month. If you would prefer to pay weekly or fortnightly, this is also viable. For sinking funds where you may not know the total cost, make an educated guess. Set aside an achievable amount each month until you reach your estimated goal. Something is better than nothing!
Choose where to put your sinking fund based on your timeline. For expenses that you will need to pay off in the short-term, keep the money in a liquid account. Freedom to withdraw funds will prevent early withdrawal fees associated with long-term deposits. The most popular choice is to open a new savings account specifically for your sinking fund. Set up an automatic payment each month, so you’ll be contributing to your sinking fund with minimal effort. Alternatively, withdraw cash to keep a physical reminder of your savings progress.
When saving for expenses in the long-term, such as several months or years in the future, your approach should be different. For these cases, it will be more financially profitable to deposit your money into a fund with a higher yield, such as a fixed-term deposit or a high-yield savings account.
Think of a sinking fund as a safety net for a planned expense. Such a simple concept will keep you on top of your larger payments while keeping you from slipping into unwelcome debt.
Maia Fletcher is a freelance writer from the sunny city of Gisborne, New Zealand. Since starting her career, she has taken an interest in reading books about business and personal finance. She also loves sharing her thoughts on this topic through her blog.