First things first. What is a sinking fund? A sinking fund is put in place to cover extra expenses that are outside your normal expenses.
For example, Christmas is outside of your normal expenses. Another example is new brakes on your car. Neither of these expenses is an emergency expense, but something that is still outside of our normal expenses.
The main difference between an emergency fund and sinking fund is that you know what the sinking fund is for. An emergency account is there for the unexpected. Let’s take a look at how to use sinking funds in your budget.
Consider Upcoming Expenses
Sit down and think about what’s coming up that you’ll need to cover. It might be ordering heating oil at the end of summer, your annual auto insurance payment, or birthday or Christmas presents for your kids. Think about how much these expenses are going to cost and how long you have to come up with the money.
We have sinking funds for auto insurance, life insurance, gifts, vacation, HOA dues, church camp, auto registration, car repairs, and new car fund. Basically, we try to have a sinking fund for any expense that can be difficult to fund at one time because it's due quarterly or annually. It's much easier to save a little at a time each month.
Decide Where to Keep Your Sinking Funds
If you’re saving for something that will cost $100 or so, you can keep the money in your home. However, if you’re building a sinking fund for a new roof, you would want to keep the money in a savings account. The money should be in a place that it easy to get to but offers the right level of protection based on the amount.
I usually keep all my sinking funds in either a savings or money market account and then have a spreadsheet that designates how much is allocated to each sinking fund rather than have lots of different savings accounts.
Save Each Pay Period
You want to put money into your sinking funds each pay period. For example, one fund for birthday presents may get $25 per week, while the fund for a new roof would get $200 a week. Treat your sinking funds like any other bill. If it helps, you can set the amount to be automatically pulled from checking to savings.
Have a Sinking Fund for the Unexpected
As mentioned above, emergency funds are usually used for the unexpected. However, there are unexpected expenses that aren’t an emergency. For example, your child may have landed his first job and you want to take him out to dinner to celebrate. This is an unexpected expense, but definitely not an emergency.
Sinking funds are essential for staying on track. Without these funds, you’re likely to reach for a credit card or dip into your emergency fund. Neither of which is a good option. Sinking funds are there to help you cover those extra expenses that seem to pop up here and there.