How Sinking Funds Could Help You Manage Expenses in the New Year
Sinking funds can take your budget to the next level by helping you find ways to afford the things that matter most to you.
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A budget can be a powerful tool to help you manage your finances. As you plan out your recurring monthly expenses and variable spending (like food, dining, and entertainment), you can make sure that you're spending your money on the things that matter most to you.
Yet even if you're in the habit of using a budget each month, there's something your budgeting system might be missing. The start of a new year can be the perfect time to add this extra component — sinking funds. These small savings funds can offer a solution to help you manage your spending better in 2022.
What Is a Sinking Fund?
Certain expenses don't occur each month but you still need a plan to pay for these costs. Otherwise, you might be tempted to turn to credit cards for financing or to raid your emergency fund when those expenses inevitably come up. This is the type of situation where a sinking fund can help you.
A sinking fund is a place where you can save money for a future, planned expense. It's a type of savings account that has a specific purpose.
Once you set your sinking fund goals, you can add them to your monthly budget. In general, you'll put back a little money each month, based on the amount of each expense and how much time you have to save for it.
What Types of Expenses Can You Prepare for with Sinking Funds?
You can create a sinking fund for any expense that you expect to encounter in the future. Below are a few examples for inspiration.
- Holiday Gifts
- Birthday Celebrations
- Wedding
- Insurance Premiums
- Taxes
- Vacation
- Back to School Shopping
- Children's Activities (Summer Camps, Seasonal Sports Fees, etc.)
- Car Maintenance (Tires, Oil Changes, Tune Ups, etc.)
- Down Payment for a House
How to Fund Your Sinking Funds
Let's consider holiday gifts for a closer look at how a sinking fund works. According to CNBC, the average American planned to spend around $1,000 on gifts for the 2021 holiday season. If you wanted to save $1,000 to cover holiday costs in 2022, putting $84 per month into a sinking fund would help you accomplish that goal.
For larger goals, like putting aside money for a down payment on a home, you might want to look for ways to speed up the savings process. Perhaps you'll set aside $50 or $100 per month — whatever your budget allows. But as you receive bonuses or tax refunds, you could opt to make some bigger deposits into your sinking fund too.
Trying to reduce your variable spending might also help you save faster toward a particular goal. Imagine you budget $600 per month for household groceries. If you have a month where you spend only $550, you could direct the leftover money into the sinking fund of your choice. Saving money in one area of your budget can set you up for future success in other.
Where Can You Keep Your Sinking Funds?
Unlike long-term savings funds, like the money you put away for retirement or a child's education, you may want to withdraw the money from a sinking fund sooner rather than later. As a result, it might be helpful to keep certain sinking funds in savings account that are easier to access for deposits and withdrawals.
A general savings account might not be the best place for your sinking funds either. Sinking funds exist for specific purposes. So you may want to keep them separate from your other money.
One option to consider is creating multiple savings accounts. Several online banks offer this service and may give you the option to link to your primary bank account so you can make electronic transfers. Some banks will even let you name each sinking fund, which can help you stay motivated and track your progress.
It's worth noting that some people prefer to build sinking funds with cash. If you choose this approach, however, be sure to exercise caution. It's important to store your money in a safe location. You should also consider the fact that cash-based savings will cause you to forgo any interest your money might earn from sitting in a bank account.
Are Sinking Funds a Good Fit for Your Budget?
Sinking funds can help you plan for large expenses while staying in control of your money. Since saving money is rarely a bad financial move, sinking funds may be a good fit for almost any budget.
It is important, of course, to make sure you stay on track with all your financial goals when you start adding money to your sinking funds each month. Saving money for a vacation or holiday can be exciting. Just be sure not to abandon other important plans like building an emergency fund, paying off debt, or investing in the process.
Michelle Black, Founder of CreditWriter.com is a leading credit expert, financial writer, and speaker with nearly two decades of experience. Her work has been featured with major outlets such as Forbes, Reader's Digest, and U.S. News and World Report.