What is a Sinking Fund & Why You Need Them?
A sinking fund is monies that you set aside to pay for future expenses. This fund is completely separate from your savings and emergency fund.
Sinking funds keep you from dipping into your savings account or emergency fund when something comes up. It also keeps you from using your paycheck to pay for expenses that you could have planned ahead of time.
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Difference Between Sinking Funds and an Emergency Fund
Sinking funds and emergency funds are both essential if you want to have financial success.
There are certain expenses that you know will come up every single year and certain expenses you just cannot plan for, i.e. apartment flooding, or unexpectedly losing your job.
An emergency fund is a savings account that will cover up to 3-6 months worth of the expenses. How much you decided to save for your emergency depends on what you are comfortable with.
Statistics show that most individuals do not have at least $1,000 in their emergency fund. Dave Ramsey suggests that you at least have 1,000 dollars in your emergency fund when paying down debt.
Whereas as sinking fund you are basically saving up for future expenses. Christmas is on the same day every year as well as birthdays.
Have a vacation you would like to go on in 6 months. This could also be any future possible medical bills and unexpected car repairs.
Sinking Funds Examples
- Car Maintenance
How To Keep Track of Sinking Funds
Cash envelopes are a great way to save and budget money. It is a well-known fact that you save and spend less money when you pay with cash instead of a card.
Create envelopes for each category you would like to save up for and start putting your money in them.
This method requires serious discipline because this method will fail if you deep into your envelopes to cover other categories or things not in the budget.
Personally, after months of trying, this method did not work for me. I found myself always dipping into my envelopes for things, defeating the purpose of the envelopes.
Most banks allow you to have as many savings accounts as you want and allow you to give them fun nicknames.
Putting your sinking funds in a savings account will limit your ability to access. Most banks put a limit on the number of times you may withdraw from a savings account and excess withdraws may result in bank fees.
Because there is a limit on the number of withdraws you can make on this account it really limits your ability to use the funds whenever you want.
For this reason, I found that a savings account work best for me when it comes to my sinking funds.
How Sinking Funds Make Paying Down Debt Easier
One of the biggest reasons I was hesitant about starting a sinking fund was because I was also trying to pay down debt as well.
One thing I learned is that having sinking funds will actually help you reach your debt payment goals faster. Having money saved for future expenses will keep you from dipping into or slowing your monthly debt payment.
For example, your car breaks down and it cost you 300 dollars to fix it. With your car maintenance sinking fund you never have to touch your monthly paycheck to pay for the expenses because you planned ahead for these situations.
Whereas, without a sinking find you may find yourself scrambling to find the money, stopping your debt payment for the month, or using your emergency fund.
Essentially, sinkings funds are meant to make your financial life easier. There is nothing like being overly prepared for anything the requires you to spend money.