How To Use Sinking Funds

The average budget covers saving for known short to long-term events that occur regularly (buying groceries, making car payments, paying utility bills, etc.). That makes most budgets incomplete. You have many needs that (timewise) are less predictable—needs like an unexpected car repair or a doctor visit. I’m sure you can come up with a lot more. To prepare financially for these, I use sinking funds in my budget. Every payday, I set aside money for things I know/think I will need some time (“some time” being the operative word) in the future. Sinking funds are essential in my financial planning. Knowing how to use sinking funds is essential to preserving your budget.

Many people find their budget doesn’t work. Some of the problems maybe they are not using sinking funds correctly or not at all. Sinking funds will help you save money. To learn more read on.

How To Use Sinking Funds

If you have ever saved for something special like a car, book, game, or phone. you were using a sinking fund. Setting money aside is a very effective way to save for an upcoming event or new items.

Let’s dive a little deeper.

What Is A Sinking Fund

Sinking funds are small amounts of money set aside for future use.  Think of each sinking fund as an individual savings account for a specific item like new tires, a broken tooth, or the need to buy a plane ticket so you can get to your parents or another relative to help them through a disaster.

Why Use Sinking Funds

The two top reasons for using sinking funds are (1) they can help you manage your money for events you know likely to occur but cannot be scheduled, and (2) they help preserve your emergency account—really, your whole budget.

Help To Manage  Your Money

The average person faces a host of expenses that will, at some point in time, become real bills. If you own your home, replacing your hot water heater is one of these.

Most of us also have to anticipate some events that quite possibly could happen and, if they do, are likely to be expensive. Here’s an example: When my children were in high school, they were in the marching band. We knew that every year we would need to rent uniforms and pay to have them cleaned. We had a category in our budget labeled “Band” to cover these and other regular expenses associated with the kids’ participation, things like snacks and transportation to scheduled events. But, as with most bands, there was always the possibility of an invitational based on performance. Those are expensive events. Often the school has fundraisers to help with transportation and hotels, but parents still have to contribute, and if we wanted to accompany the kids…well, those costs would be all on us.

In our budget under the category of “Band”, we had a sinking fund for this type of event. Early on, we were fairly sure our oldest child would be in the marching band. So, we actually started saving for band-associated expenses while he was in middle school. Every payday we would set aside a specific amount of money towards what we knew we’d need and designate a small part of it towards expenses we might encounter. Paying that way—in small chunks—makes it easier to keep your budge intact when need for extra money arises. (Note: I need to mention that we didn’t always have to use the money we saved for the special events. In that case, we could consider ourselves ahead for the next year or redirect the funds towards something else: Over the twelve years that we had kids in high school, we did both.)

Save Your Emergency Account

One day my wife and I were out driving, doing our usual errands. There was a loud bang, the car shook and pulled hard to the right. We’d had a blowout. We needed a new tire.

We had four ways to handle this. We could put the new tire on credit. We could get into our emergency account and buy another tire. We could go to our tire fund (which is itself a sinking fund) and purchase a tire. Or, we could use money from our auto repair sinking fund.

Anybody that knows me knows if there is a way to avoid using credit, I do. (I really don’t like paying—in the form of interest—to use someone else’s money.) Also, a long time ago, we decided that our emergency fund was to be used solely for bona fide emergencies. We’d get into those funds when our only other option was credit. (I will tell you that years ago, a blowout would have qualified as an emergency for us. Before we had built up funds in our budget, we would have had no way to purchase a tire except by using a credit card; junior enlisted people in the navy don’t make much money) Now in addition to a tire fund, we have a sinking fund for repairs under our auto category. Its purpose is to help with anything unexpected expenses associated with our vehicles. Well…we decided we wanted to keep our tire fund intact and continue adding to it for when we’d need to replace the set. Since we only needed one tire and we had enough money in the auto repair sinking fund, it made sense to make the purchase from there.

When To Use Sinking Funds

The idea behind sinking funds is to identify probable expenses and save to have the money to pay them. These are expenses it’s reasonable to assume you will face, but I can’t really put a due date too. For example, a fund for car repair could be considered a sinking fund. Who knows when some unexpected work will need to be done? On the other hand, your car payment is not a sinking fund. You know exactly when and how much each payment is scheduled for. Your health and auto insurance are other examples of expenses that don’t fit the mold for a sinking fund. Those are scheduled payments. Co-pays and deductibles, however, do. Even though we’re likely to have some expected doctor visits, there’s always the possibility of a medical emergency. And after an accident, who wants to have to figure out where the money for an insurance deductible is coming from?

Sinking funds are the “go to” source for money to cover these types of events. They can help you avoid raiding money that needs to go for your regular expenses.

How To Identify What To Save For

Services we receive (insurance policies, warranties, etc.) often come with a financial responsibility our minds tend to minimize until we need to use them. Car and medical insurance are excellent examples: Both have deductibles.  Health insurance also has a co-payment and an annual maximum out-of-pocket.

If you had to use your insurance today, could you cover any deductibles or maximum out-of-pocket expenses? Would you have ready funds? Would your only recourse be to charge them? Or, maybe, you’d think to take it from another part of your budget (in essence, robbing yourself)?

Appliance warranties, say for your air conditioner or hot water heater, may have policies similar to insurance: If the new a/c you bought requires maintenance, you may be required to pay the first $200 or so of that cost.

Everything we own will need to be replaced or repaired at some time. In my opinion, we should have a sinking fund for each item, but here’s the catch…While there is no shortage of things for which we could use a sinking fund, the money we can use to build them will only go so far. Your income and regular expenses will impose a limit on how much you can invest in sinking funds. After you’ve decided what you are saving for, determine what amount of money would be reasonable to have on hand to cover the event should it happen. Save that amount by making small regular deposits to the sinking fund. After you’ve accumulated the total, assign future deposits to something else.

In one case, I did this: In a sinking fund, I saved enough money to cover two auto insurance claim deductibles. Now I just let that sit, and the money I was putting towards that possible need goes toward something else. The same is true of my tire fund. Right now I have about three-quarters the amount I’ll (someday—probably sometime next year) need to replace the set. When I have enough in that fund, I’ll find another use (another sinking fund) for the money I’ve been depositing to it. That is, until I’ve purchased my new tires. Tires are an important item, so as soon at that sinking fund is depleted, I’ll start building it back up.

After you’ve had to tap a particular sinking fund, you can make an evaluation as to how quickly it needs to be rebuilt and reassign funds as needed.

When you start thinking about what you could use a sinking fund for, consider the event most likely to occur for which having cash on hand would benefit you. Some people want to save the  annual maximum out of pocket for medical treatment. Others may want to save for car repair. Whatever, you should pick something that will help you build yourself a financial safety net. As you save in anticipation of preserving your finances in the event of a potential disaster, you are being frugal.

Sinking funds are a good money management tool. 

If you decide to start using sinking funds, likelihood and urgency need to be your guides. You need to ask yourself, “What is the most likely event I need to save for?” Expense needs to be factored in, also. And it’s personal. I tend to want to chip away at the possibility of not having enough money to cover a big-ticket opportunity, but I know people who would rather cover a bunch of smaller problems first. However, you decide to go, make it part of your budget. Every payday contributes to the sinking fund. Remember, deposits to your sinking fund(s) don’t have to be large; you’re working on the supposition that it will be a while before you’ll need this money.

Keep Your Sinking Funds Safe And Available

I keep all of my sinking funds in one savings account. I have a debit card for the account. I can also transfer money from this account to my checking account. That makes money easy to get to when I need it.

I use an excel spreadsheet to check my progress toward fully funding whatever I’m currently saving for. Let’s say I need $800 dollars to replace my tires. I can look at my spreadsheet and know how close I am to having that amount—and how seriously I need to think about what I want to save for next..

Conclusion

Knowing how to use sinking funds will save you money and creates an opportunity to be more deliberate with your money.

The benefit of using sinking funds is twofold. Sinking funds help you maximize the use of the money you have on hand, allowing you to prepare (financially) for the future.