Ever hear of “Murphy”? He’s the guy that shows up when you least want him to. He’s the flat tire just after you budgeted to the last dollar and don’t have money left over to replace/fix it. He’s the extra expensive electric bill that you didn’t plan for that is due this month because of excess usage. Murphy is anything that goes wrong that we don’t plan for. Don’t let Murphy get you down! With a sinking fund, it’s like having Murphy repellent!
Maybe you’ve heard the term “sinking fund” thrown around, maybe you haven’t. I want to take some time to dive into what they are and how we use them in our budgeting every month.
So, basically a sinking fund is just money you set aside to buy things that cost money at various intervals.
Some great ideas for things you would use a sinking fund for include, but are not limited to:
- Yearly Auto Insurance
- Property Taxes (if you are not escrowed)
- House Repairs
- Car Repairs
- Association Dues (if they are not monthly)
- Fun Money
- Car replacement
- Technology/jewelry/other fun things you want to purchase
- many other things
Most of the items you see on this list are items that vary from month to month (clothing, car repairs, gifts) and there are some that are paid yearly or bi-annually.
The advantage to using this is that when the bill comes due, you will have the money saved up so that it doesn’t become an emergency or a crisis. Take auto insurance, for example. We pay ours annually because we get the biggest discount that way. All we do is take the amount that it costs for the whole year and divide that number by 12 months and then save that amount each month into the fund.
Example: 12 months of insurance runs $720. We take $720/12=$60/month. We then budget for $60/month to set aside as we pay our bills. Instead of paying the insurance company each month, we just transfer that money into our Sinking Fund account and let it build up until the bill comes due in 12 more months. At that time, we will have $720 saved up and will shop around for new car insurance to make sure we are still getting the best deal. If we can save even more money, we can free the savings up and move it towards whatever goal we want or leave it in there and lower our costs even more for the next year.
By doing this, we are able to get a better deal because we have more options available to us.
On the other hand, there are items out there that vary from month to month and tend to come up, but, only at different times. These are things that the better you track how you spend, the better you will be at forecasting how much they will cost in the future. A prime example of this is our gift budget. We like to write our all the different events that come up ahead of time and try to figure out how much we want to give to each event. Some of these things include:
- Holidays (Christmas, Thanksgiving, Easter, etc)
- Kid’s events (parties and gifts)
- Hosted events
- Extra unforeseen events (stuff that comes up last minute that we can allow ourselves to say yes to.)
By planning this out to the best of our ability, we are able to forecast what it’s going to cost us in this category for the year. Again, we just add up everything and divide the number by 12 months and start transferring that money into the sinking fund for gifts each month.
What happens if you don’t have enough in there at the time you want to make the purchase? This happens from time to time with our variable accounts. What we do is make sure that we are not over our yearly amount. If not, we allow ourselves to “rob Peter to pay Paul” in a way. Since all of our “sinking funds” are shared in one account overall, the overall account should almost never run the risk of going negative. Because things should be spread out, you will almost always have enough money in the account as a whole that you might be able to go negative in one fund for a short time while it’s funding itself over the monthly allotments.
The warning that I will throw up here is that you have to be very careful to make sure you don’t go over your yearly amounts or you will start running in the red very quickly and might have to adjust your sinking fund contributions to make this work from time to time. What I do is try to review our different funds and how much we have spent over the past 12 months on a rolling 6 month window. This is very easy to do as long as you’ve been tracking your transactions. I just use Mint.com and look at the last 12 months for a certain category and it adds up all the money that I’ve spent over that time frame. I verify that this amount is on track with what I’m putting away and adjust if necessary. By doing this, I don’t know how many times I was over saving for something that I thought I needed. This allows you to do checkups at regular intervals and stay ahead of your funds and how well they are funded.
What We Do
For my wife and I, sinking funds allow us to keep the budget very boring and steady. Because last minute things that come up like random birthday parties, car repairs, home repairs, etc don’t have to cause a huge fight anymore. Because we’ve done the legwork, we have the money saved to cover these expenses for the most part without having to even come close to touching our emergency fund. The sinking fund basically acts to provide a buffer for when things start to spiral out of control in those months when everything seems to be going wrong.
So, do you use sinking funds? If so, do you keep them all in one account or separate? Do you want to start one now? Do you need any help? Let me know!