What are sinking funds? It can be a difficult concept to understand. In this article I will explain to you simply what they are.
If you are just starting out you might be finding the budgeting terminology difficult to get to grips with. I found this topic mind boggling when I started. I knew that there were only a certain amount of things I was going to be able to sink fund for. However, it appeared in the discussion around sinking funds that you needed to sink fund for everything!
I decided to figure out a way to make this concept work for me. I didn’t have the income to sink fund for everything and I’m pretty sure you probably don’t either!
Let me explain my simple approach to sinking funds to help avoid the sinking fund panic.
1.What Are Sinking Funds
It is a saving fund towards an event or purchase that you KNOW is going to happen.
An example of a sinking fund could be:
- Basic home maintenance like chimney cleaning or boiler maintenance
- Car replacement fund
- A basket of annual bills such as insurances i.e. life, contents, motor
What is the purpose of a sinking fund?
It’s there to help you avoid taking out more debt to pay for the things you need in your life. Sinking funds run well will help you to avoid using your emergency fund which I aim to never use if at all possible.
But remember this, a sinking fund is essentially an idea. It is not a physical thing. so it’s up to you how you’d like to organise them.
2.Decide What Is A Sinking Fund In Your House.
Everyone will tell you that you should sink fund this, but not sink fund that. This is fine, but at the end of the day, it’s your household and your budget and you need to decide how this is going to work in your world.
A household budget is comprised of two basic categories;
- Money coming in.
- Money going out.
In the money going out category, you will have to analyse how much of that can be allocated to sinking funds. You will then have to decide what those sinking funds will be and potentially what sinking funds you will have to shelve for a while if the funds are there to service them.
Read this post to work out your household numbers before you write your first budget. This is key step before ever worrying about sinking funds!
3.Get Over Your ‘Analysis Paralysis’ As Quick As You Can.
How you manage each of those categories is really up to you. We should take the advice and knowledge of experts as just helpful advice, but not get completely caught up in how those experts apply those principles. That was a huge time waster for me when I started budgeting. I learned a lot from the big guns in the debt free space, but I had to let go of some of the advice, and just make it work for me. Sinking funds nearly drove me to distraction, but when it came down to it I only had a certain amount of income.
I decided to do my best and forget the rest.
4. Make A List Of Sinking Funds That Are Priorities For Your Household
I listed the things that I did not have on direct debit in my bank account, first. An example of this would be car insurance. I don’t know about where you live, but where I live car insurance is expensive. I like to pay it once a year, rather than monthly by direct debit.
This got me thinking about all of those kinds of annual insurances and bills. I decided that my first priority sinking funds were going to be all of my insurances.
Theses sinking funds were are follows;
- Car insurance
- Contents insurance
- Life insurance
These bills were due, mainly in the first quarter of the year, so they became my some of my first quarter sinking funds. With the list beginning to make sense I thought about the whole year from this perspective. What other period in the year normally knocked me off course with my finances?
I could immediately think of several time such as;
- Summer holidays and vacations
- Back to school time
- Christmas and the winter season in general
Before I knew it, I could see a pattern emerging. If I divided the year into quarters or seasons, and bunched together the bills and expenses associated with this time of year, I had my priority sinking fund list decided on.
Decide What Is A Sinking Fund In Your House
What I call a sinking fund, you might call and expense, and that is ok! I get to manage my money how it suits me and you get to do the same. For some households its easier to put sinking funds and savings on direct debit. For some households its not as straight forward as income frequency varies and amounts may be irregular.
There is room for everyone’s approach. The ultimate goal for me, is getting the bills paid and keeping you family safe and happy. Decide what budget item goes into expenses and what item goes into sinking funds and be ok with it, regardless of what else you read on the internet!
6. Now What?
So at this stage, we have decided what we would like to put into sinking funds, but do we know how much we need to have saved into those sinking funds?
This is how I figured it out.
Add up all your sinking funds projected amounts for the year, and divide that number by 12 or 52. Now you can see how much needs to go into sinking funds each week or month.
Here is an example:
My sinking funds cost €10,000 each year. My sinking funds include the above mentioned categories (which broken down, include lots of little things by the way!). I divide €10,000 by 12 and I get €833.
So what’s the next step?
I’ve got my list of sinking funds, and I know how much it will cost me each year to service those sinking funds. Now decide where you will keep your list, and where you will put your money each week or month.
Here’s an example;
I use an excel spread sheet to keep my annual sinking fund amounts together in one place. I keep my sinking fund mainly money in savings accounts and occasionally in cash envelopes.
If you want to make sure you have money for your most important sinking funds, you need to put that amount of money away each month or you’ll run into trouble.
7. The Reality Is, There Will Probably Have To Be Cut Backs.
That number you just calculated, is it too much for you to get together each month?
It was too much for me to get together each month when I started to use sinking funds and that’s is where budget cuts come in. Where can you make savings? Can you cut back on your weekly household spending to be able to put that extra into your sinking funds savings?
Let me give you an example:
I needed to find extra money each week to put into sinking funds, when I first started budgeting. Each of my household bills was analysed and I managed to cut back a little on each of them by ringing up providers and requesting reductions or quitting contracts. I saved about €20 a week by doing that. Not much you might say!
€20 = €1040 per year.
€1040 of my total annual sinking funds is over 10% of what I need per year. Suddenly, €20 per week is a big deal. To put this in context, €1040 is more than I spend on Christmas. Can you cut back on your grocery spending? I cut my grocery spending by 50% during my no spend year ( which you can read about here)and paid off €10,000 in debt in one year on my own.
9. The Numbers Don’t Lie, Take Your Time To Get To Know Your Numbers.
Not knowing your numbers before you start budgeting and sinking funds, results in you constantly running into a ditch. You’ll be dipping into your emergency fund and missing deadlines for things you need to pay out for and get completely fed up with it all.
You have to know your numbers before you start. If you don’t have the money to meet all of your budgeting goals and ideas, you have to cut back and you need to think about the possibility of earning more somehow.
Working your sinking funds into you budget takes time. If you can get your numbers straight before you start you will be on to a winner and save yourself so much time and heartache.
I hope you enjoyed….