What are Sinking Funds and How Should I Use Them?

What are Sinking Funds and How Should I Use Them?

Sinking funds are budgetary needs for which you save a specific amount each month. Then, when the total amount is saved, you spend it, tracking each expense from that sinking fund, to insure you don’t spend more than you have available.

You can really make just about any budget category into a sinking fund. However, some budget categories lend themselves better to this approach.

What’s the difference between sinking funds and the envelope system?

Sinking funds generally involve larger amounts of money, saved up over a longer period of time. The envelope system is traditionally used for budget categories which occur every month.You put the entire amount in cash into an envelope and spend only from that envelope for 30 day. Groceries or household items work really well for envelope budgeting.

Having said that, there’s nothing wrong with sticking your sinking fund in an envelope and taking money out every time you buy something related to that sinking fund. For instance, it’s a great idea to put twelve months of clothing money into an envelope. Label it “clothing” and then only buy clothing items with that money. You will be able to track your clothing expenses and how much you have left in that sinking fund very easily this way.

Why Would I Want to Use Sinking Funds?

Sinking funds are great for short-term goals, like taking that dream vacation to Disney. Let’s say you decide you and the rest of the fam are headed to see Mickey and friends in two years from now.

Take the number of months between now and your epic trip, divide the total amount of money you need by that number of months. Then save the designated amount. When you have saved the total amount, you can book your dream vacation.

However, sinking fund also work equally well with certain regular budget categories like:

  • Clothing
  • Gifts
  • Christmas
  • School Supplies
  • Home Furnishings
  • Car Upkeep
  • Home Maintenance

How Do Sinking Funds Work?

Here’s an example from my own budget.

In the 2020 budget, I save $30 every month for Christmas. Our entire Christmas budget is just $360. So, by saving $30 a month, I have the $360 in our account by the end of the year.

I can hear you screaming loudly, “But, Christmas is in December, not in January!”

That’s right!

The $30 a month allocated to save monthly in my 2020 budget is for Christmas 2021.

The $360 that I am spending for Christmas this year, was already in the bank on January 1st, waiting for me to find screaming-good deals on items appropriate for each person on my list. By the time November 1st rolls around I will already have bought 80% of my holiday gifts (generally at a small fraction of regular retail prices!) Each item is inventoried and kept organized in my gift stash.

I track each purchase in the “Christmas sinking funds” portion of our budget to ensure that I don’t go over the amount we have allotted for the holidays.

Sinking funds are a great way to incentivize saving for goals and also provide a degree of insurance against going over your allotted budget.

Do you use sinking funds? If so, how?

Leave your thoughts in the comments.

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