Intentionally planning for larger expenses is a crucial part of a successful financial plan. From larger items like replacing a car and a home purchase to more recurring items like annual subscriptions or a vacation. Having an appropriate savings plan and knowing how to use a sinking fund is key.
What is a sinking fund?
Put simply, a sinking fund is systematically setting aside money every month to ensure there are enough funds to handle the expense by the time it is here. To get a better idea, let’s list a few items for which we might create a sinking fund. We will then look at how to use a sinking fund to cover these expenses.
Car replacement
Christmas Gifts
Wedding
Costco Membership
Vehicle Registration
New Computer
There are several other items that we might need to create a plan with internality to ensure we are prepared to handle them when they arrive. This is a good list, to start our conversation and get you more comfortable with the idea of a sinking fund.
Is it a large expense?
This is the key question when we are looking at sinking funds. It is extremely relevant to your situation. Is the expense small enough that we can absorb it into the month’s budget? Depending on your financial situation, this answer could be different for several people.
Mary has $500 available of discretionary spending each month, she could pay for her vehicle registration, possibly buy a new computer and pay the Costco membership all in the same month, without a sinking fund. On the other hand, Randall is trying to figure out how to buy groceries while still being current on his student loan payments, he might need to plan for those same exact purchases for several months.
How long until the expense?
Is it an annual expense? Is this expense coming next month? Or are we five years away from it? Having this detail is key to setting up a plan and utilizing a sinking fund. Let’s use the example of a wedding. You are getting several congratulations on your engagement. Then it hits you. There is a wedding expense in the future. You have picked a day, it is 11 months away. Pretty easy here. We have 11 months to save.
How much is the expense?
Staying with the wedding example, after we visit the venue, the photographer, pick out the dress, cake and cut down the guest list, we are looking at a wedding cost of $22,000. Simply divide the amount by the number of months we have to save for it.
In our wedding example here, I can do the math in my head. It is $2,000 a month that we need to save in order to have the $22,000 by the end of the 11 months. Yes, some items will need deposits and all monies are not due on the wedding day, but at $2,000 a month, in four months we have $8,000 to readily handle expenses and deposits as they arise.
Will we get there in time?
This is when the rubber hits the road. This is where we determine how hard we are going to work. Are we willing to work harder for a larger goal, or are we limited by what we can do? Is this a reasonable goal? Saving $2,000 a month might sound fairly challenging to some, easy to others, and just plain impossible to many more. If we can only afford $500 per month, the budget for the wedding will decrease. Maybe we can push it back to allow more time or pick up another job or two to have the wedding we’ve been dreaming about. I am not saying this is easy. But using a sinking fund allows us to plan. It will also help us prioritize our financial goals.
A car repair may become a priority over saving for a wedding, but a new car may not. Having priorities towards some of your bigger financial goals is key.
How to use a sinking fund
I don’t want someone to read this post and figure they will never have the wedding they dreamed about. My hope is that this basic principle allows you to better prepare for the expenses that are headed your way. Let’s take a look at our list of examples that we saw at the beginning and see what a sinking fund plan may look for each one.
Car replacement (used vehicle) – $10,000 with 5 years to save = $167 per month
Christmas Gifts (gifts for a family of 6) – $1,500 with 12 months to save = $125 per month
Wedding – $22,000 with 11 months to save = $2,000 per month
Costco Membership – $60 either pay it in the month it is due or spread it over 3 months = $20 per month
Vehicle Registration (NJ) – $72 either pay it in the month it is due or spread it over 2 months = $36 per month
New Computer – $600 with 6 months to save = $100 per month
This is how to use a sinking fund. The sinking fund principle can be applied to a whole host of different expenses. The key is to have a plan for the expenses that we can see coming so that we can decrease the number of financial surprises we experience.
Looking for additional support
If you want additional help or guidance on determining how you can best use a sinking fund, please reach out to me for a free consultation.