How to Utilize Sinking Funds to Improve Your Budget

 

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Imagine it’s the end of October. The stores are replacing their Halloween displays with Christmas displays. You start thinking about all the things you need to do between now and Christmas, including buying lots of presents for friends and family.

But then you start worrying about how you’re going to pay for all those presents. Last year, you spent almost $1,000. You had to put all the purchases on your credit card and it took you months to pay it off.

But when you check your bank account, you realize you aren’t going to have enough to buy everything. And your paychecks between now and Christmas won’t be enough either, once you pay for all your other bills. You dread having to charge everything again this year.

Or maybe a similar feeling of dread comes over you whenever your car needs maintenance because you don’t have the money to pay for it.

Do either of these sound familiar? Are you sick of not having enough money when you need to pay for irregular expenses like Christmas and car maintenance?

Let me share with you how “sinking funds” will allow you to pay for your irregular expenses without going into debt.
 

 
Are you sick of not having enough money when you need to pay for irregular expenses like Christmas and car maintenance? Let me share with you how “sinking funds” will allow you to pay for your irregular expenses without going into debt.
 


Why is it that irregular expenses tend to make us go into debt? The simple answer is “out of sight, out of mind”. Until Christmas is just around the corner or our car breaks down, we forget about these expenses.

And, because we forget about them, we don’t set aside money to pay for them. Then, when they occur, we have to put the purchase on our credit card and pay it off (plus interest) over time.

The solution is to budget for these items by creating a “sinking fund” for them.

What is a sinking fund?

A sinking fund is a fund where you set aside money each month so that you’ll have enough money saved to cover an expense.

It works like an escrow account through your mortgage company. When you have a mortgage, you’re usually required to pay money every month into an escrow account to pay for your homeowner’s insurance and property taxes. The mortgage company keeps this money in the bank until it’s time to pay your insurance or tax bill. They do this to ensure that both get paid.

Well, you can create your own account for your irregular expenses to ensure that you have enough money to pay for those expenses whenever they occur. Then you’ll no longer need to use your emergency fund or create new debt to pay for them.

Let’s take a look at exactly how to create your sinking funds.

Step 1 - Determine your irregular expenses

The first step in setting up your sinking funds is to create a list of your irregular expenses. Every person’s list will be different.

As you create this list, you’ll also figure out approximately how much you spend on each expense, how often you pay for each expense, and when each expense is due.

I also suggest determining whether each expense is either fixed or variable. Fixed expenses are those where the amount you pay each time is the same. Whereas variable expenses are those where the amount fluctuates.

Step 2 - Determine how much you need to save each month

Now that you have a list of all your expenses, the second step is to figure out how much you need to save each month for them.

Fixed expenses with fixed due dates

Some irregular expenses have a fixed amount due and are due on a particular day or in a particular month. Examples of these type of expenses include car inspection, subscriptions, medical copays, and tax preparation.

For these expenses, you divide the amount due at each instance by the number of months until it is due. The resulting number is the amount you set aside each month. (If you are paid weekly, I suggest dividing the monthly amount by 4 and setting that amount aside each week. If you are paid biweekly or twice a month, I suggest dividing the monthly amount by 2 and setting that amount aside each pay period.)

For example, let’s say you pay $180 every March to have your taxes prepared. It is currently July 1 and you just got paid, giving you 9 months to save. This would mean you’d need to set aside $20 each month to have $180 in March.

Variable expenses with fixed due dates

Some irregular expenses have a variable amount due and are due on a particular day or in a particular month. Examples of these type of expenses include Christmas and other gifts, car insurance, and quarterly estimated taxes.

For these expenses, you need to create a reasonable estimate based on past or anticipated spending. Then, you divide the estimated amount by the number of months until it is due. The resulting number is the amount you set aside each month.

For example, let’s say you anticipate spending $750 on Christmas gifts. It is currently July 1 and you just got paid, giving you 6 months to save. So you’d need to set aside $125 each month to have $750 in December. (But if you buy all your gifts in November, you’d need to set aside $150 each month.)

You can always adjust your numbers if you find you are over-saving or under-saving.

Variable expenses without fixed due date

Lastly, some irregular expenses have a variable amount due and they can occur at any time. Examples of these type of expenses include car maintenance, clothing, medical bills, and house maintenance.

For these expenses, you need to create a reasonable estimate for the year based on past or anticipated spending. Then, you divide the estimated amount by 12. The resulting number is the amount you set aside each month.

For example, let’s say you anticipate spending $1,000 on car maintenance every year. It is currently July 1 and you just got paid, giving you 6 months until the end of the year. So you’d need to set aside $166.67 each month. (Whatever you don’t spend during the current year rolls over to the next year.)

You can always adjust your numbers if you find you are over-saving or under-saving.

Step 3 - Manage Your Sinking Funds

There are two great ways to manage all your sinking funds.

First, you can a separate savings account for each sinking fund. Each month, you deposit the amount determined in Step 2 into the appropriate account. Then, when you the time comes to spend the money, you transfer the amount needed into your checking account.

I highly recommend using Capital One 360 because you can open up to 25 accounts, there are no fees or minimum balances, and the interest rate is higher than traditional banks.

Second, you can create one separate savings account where you deposit all money for all sinking funds (again, I recommend Capital One 360). Then, you can use a spreadsheet or software to track each fund.

Currently, I use the second method and use YNAB to keep track of everything. YNAB was created to handle this exact situation and is one of the reasons I love it so much. It makes keeping track of all my expenses (both budgeting and spending) so easy.

With YNAB, I create separate categories for each sinking fund. When money is deposited into my account, I allocate money to each sinking fund. Then, when I spend money on a sinking fund expense, I assign that spending to the correct category.

Here is a screenshot of my YNAB account showing what this looks like:

Are you sick of not having enough money when you need to pay for irregular expenses like Christmas and car maintenance? Let me share with you how “sinking funds” will allow you to pay for your irregular expenses without going into debt.

As you can see from this screenshot, we had to adjust our budget because the cost of removing the tree ended up being more than we'd hoped/planned for. But the tree was a danger to us and our neighbors, so it needed to come down sooner than later.

So that we didn't take on any debt, we took money from other expenses that were lower priority (such as saving for a cruise and saving to replace some windows). We also had over-budgeted on my car insurance and our life insurance, so we moved the extra to the tree. Making these adjustments was so each using YNAB.

Final Thoughts

It’s essential to plan for your irregular expenses. Otherwise, you’ll take on new debt to buy new tires or pay for Christmas presents. Utilizing sinking funds will bring you peace of mind because you know you’ll have the money to pay for those expenses.

Your Turn

What sinking funds do you have or plan to set up? Or do you use some other method to save for those irregular expenses?