The Magic of a Sinking Fund
What Is It?
The term sinking fund is not something we are used to hearing these days, but it is probably something your grandmother used on a daily basis. The basic principal is to take an amount of money that will be needed at a certain time and divide it by how many months or years until it is needed. Then that amount is set aside each month so when the term of the fund is over the money is there to do whatever was need it.
How Does It Work?
For example if I want to have a certain amount to spend for Christmas and it is 6 months until Christmas I take the total amount I want– let’s make it easy and say $600– if I want $600 to spend on Christmas in 6 months that means I must save $100 each month for that purpose. This is exactly what “Christmas Club” savings accounts that are offered at many banks are.
Or for another example: I am usually shocked every year by the hit to my budget to renew the vehicle registrations on the vehicles that we own. So what I should do is — when that shock is upon me — I should set up a sinking fund for it. Say it costs me $200 to do renew these plates. In 12 months I will need to do this again so let’s say $240 (to make the math easy) divided by 12, that means that I need to set aside $20 each month so that when the 12 months is over I have the money sitting there to do my plates.
You can actually go on that vacation — without debt. Save $100 a month for ten months and take a $1000 trip, paid for!
Most Importantly–Where’s the Magic?
If we would learn this and apply this principal we would save a lot of money in our daily lives. Not to mention stress!
For example many insurance premiums are billed quarterly. But most of us are not disciplined enough to pay that to ourselves on a monthly basis. So its like free month, free month, slam! free month, free month, slam! So if I create a sinking fund for my insurance payments and I put $80 into it each month, then I have $240 each quarter ready to pay the premium when it is due. One way this saves us money is we don’t pay the installment fee that most insurance companies charge to bill us monthly. That’s free Starbucks–or an extra mani-pedi.
Okay that’s small potatoes. Now let’s look at it on a grander scale.
Let’s look at things like the roof on your house or your furnace or your air conditioning system or car replacement. These are huge hits to our budgets. We tend to go riding along through life just enjoying our dry roof, enjoying our blasting AC, enjoying not getting stranded in our car — until they wear out. And then were like, “oh my goodness! how am I going to afford this huge repair or upgrade!” It is much harder to handle a five or ten grand budget item when it is a surprise. If we get into the habit of planning for the “unforeseen” and have the expenses factored into our daily budget, we can actually weather these times without them being a crisis. Too often our poor planning “forces” us to use credit for these unnecessary crises and we end up paying interest.
Planning this way does certain things for you. It helps your life stay peaceful not to be in panic mode. When you have the money there when it’s needed, you don’t have to feel guilty — because it was saved for this exact purpose. You have time to shop around for a good rate instead of having to make a decision when you’re in crisis.
Imagine the freedom if you had saved $200 per month for 20 months and you could walk into a car dealership with $4,000 cash in your hand to buy whatever vehicle that suited your purposes. You’re sure to get a great deal when you pay cash and you wouldn’t have to worry about pleasing their finance approval manager!
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