Have you ever heard the words sinking fund and thought to yourself it sounds like something really complicated?
Perhaps it sounds so complicated that it can’t possibly apply to you.
Don’t worry I’ve been there too.
A sinking fund is actually really simple to understand.
I’m going to explain what a sinking fund is.
How it can help you.
Why you need one for your family.
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What is a sinking fund?
A sinking fund quite simply put is a pool of money that you put away each month in order to pay for a large bill that is heading your way.
We all have expenses that need to be paid for yearly. There is nothing worse and more dreading than waiting for that bill to hit your carpet when you wake up in the morning.
A sinking fund solves that problem for you.
If you know you have a bill that will be due next year, you simply start saving each month towards it so that you have the money ready and waiting when the bill arrives.
For example, your home insurance might be $600 for the year so you simply start saving money towards it each month to make sure you have enough when the bill is due.
How can a sinking fund help me?
Sinking funds are great for helping you to manage your money better.
No one wants to be searching all over trying to make ends meet in order to pay a bill.
There is so much stress attached to trying to pay yearly bills and by implementing a simple thing like a sinking fund all the stress simply goes away.
By forward planning your bills you can make sure that when those bills do come around you are fully prepared for it.
I use this method myself and it helps a great deal because I no longer have to fear hearing the letterbox in the mornings because I know I already have the money set aside to pay the bill.
Another benefit of using a sinking fund is that you have the capability of paying for bills yearly rather than monthly which will more than likely cost you extra in interest rate charges.
If you can pay bills by the year its usually in your benefit to do so.
You can get a copy of my free sinking fund printable at the end of this post.
What can I use a sinking fund for?
A sinking fund can be used to put money away for things like school tuition fees, annual home insurance or even Christmas and birthdays.
You can basically use it for saving towards anything that comes in yearly.
How do I go about setting one up?
To get started with your sinking fund the first thing you need to do is to pull out all your yearly bills.
Anything that you know will be coming your way that would be difficult to pay for in one go upfront.
List out all of those bills along with how much they cost.
Just remember that sometimes these bills go up each year so its good practice to always add a little extra on top.
10% would probably be a good place to start so you don’t get any surprises later on.
For example, if you know you have a medical bill to pay of $1500 for the year add another 10% to this, making it $1650.
Your bill may not have gone up by that much but its always better to have too much in your sinking fund rather than not enough.
Take that $1650 and divide it by 12 or by however many more months you have before the bill is next due.
For the sake of making it clear let’s work it out together:
$1650 / 12 months = $137
Each month you would need to put aside $137 towards paying your bill.
Do the same thing for each expense that you have.
I suggest you make these savings automated so that you don’t have to think about it each month.
Put this money into a separate account so that you don’t get it mixed up with your current account expenses.
What’s the difference between a sinking fund and everyday savings?
There is actually a big difference between a sinking fund and everyday savings because your everyday savings may not cover the bill that you need to pay.
You may decide to put away $200 each month into a savings account (which is great by the way) at the end of the year you have $2400 nicely saved up.
Now you have to pay that medical bill that we discussed earlier, so you take out the $1650 leaving you $750
$2400 – $1650 = $750
What happens when your next bill is due and you have to pay for 2 sets of car insurance totaling $800 for the year?
You now have to find an extra $50 to top up. ($750 from your savings and now $50 extra)
$50 is not too much and perhaps you can make that payment.
Now your child has just come home with a letter from school about an upcoming school trip costing $150 in 6 weeks time.
I’m sure I don’t need to explain further. You can see just how quickly things can spiral out of control.
Having a sinking fund ensures that those obligations will always be met.
Regular saving are just regular savings, they don’t have anything in mind and can be pretty much used for anything.
What’s the difference between a sinking fund and an emergency fund?
Emergency funds should ONLY be used for emergencies.
These are instances where you did not see the situation in front of you about to come.
It’s for things like your roof falling in overnight and perhaps your home insurance not being able to cover that expense.
It would be a pretty similar situation to the situation above with the regular savings.
Using emergency funds just wouldn’t work.
Final thoughts on a sinking fund
Setting up a sinking fund is essential for staying out of debt.
Getting into debt can happen in the blink of an eye and can quickly spiral out of control especially if you have an interest rate added to the cost.
The only way to avoid this is to set up a sinking fund for your family.
It’s one of the best ways to ensure financial stability for your family in the future.
Once you have all these things in place life with money will get that much more controlled for you.
Posts related to saving money:
- Why an emergency fund is so important to your family
- The cash envelope system and how it can help you