Use a Sinking Fund to Stay Afloat

Being proactive is a quality of the most highly successful people, especially when it comes to handling money. 

One of the ways to get ahead of the financial curve is to use sinking funds. A sinking fund is money that you choose to collect with a specific purpose in mind. Sinking funds are the best way to save money for a specific item that you know is going to happen quarterly, bi-annually, yearly or even a few years down the road.

Sinking funds are similar to the escrow account that is part of your mortgage. Each of your mortgage payments goes in 3 directions. One third pays down the principle amount of your loan. One third pays the interest on your loan. And the third part goes to escrow, which is money set aside to pay for your property taxes and insurance, which are usually due once a year.

The term “sinking funds” is a misnomer. They should be called “floating funds” as they keep you from sinking into debt. When it comes to personal finances, sinking funds offer a great way to plan for your future and make sure you reach the goals you’ve set. By setting the money aside before you need it, you will avoid using your emergency fund or running up credit card debt.

The sinking funds should be in liquid accounts; a high-interest money market account would be ideal. The type of account you use also depends on how far into the future you will be using it. If you are saving to buy a house in 5 years, you may want to use longer-term CD’s or an online savings account that offer a higher interest rate than your local bank does.

Sinking funds are different from your saving and investment accounts. Those are working to build wealth, and as your savings grow, it will eventually begin to work for you. This is not money that you want to dip into for short term spending.

A sinking fund is money you plan to spend with a specific goal in mind. For example, if you know you are going to have to replace your roof in 4 years, you can start saving now so you have the money saved when you need it in 4 years.

As you get better at budgeting and are more aware of where every penny is going, you can recognize areas where a sinking fund would be appropriate. Without a budget (or spending plan) it’s very hard to figure out where to use a sinking fund or how to get the money to set aside.

When you set up your sinking funds,  decide on how much you need in each category, then divide that amount by the number of months you have until you make the purchase. Save the money until you reach your goal.

Christmas always seems to be really far away, until it isn’t. January and February when all the Christmas bills start rolling in can be one of the most stressful times of the year financially for many people. Starting a sinking fund for Christmas presents is a great way to avoid the post-holiday credit card blues, and save yourself a ton of money in interest. Using cash for Christmas also helps you control spending.

Let’s say the average amount you spend for Christmas is $500. In January, create a sinking fund for Christmas and save @ $42/month. In December, you’ll have $500 to pay for Christmas expenses without going into credit card debt.  As a bonus, you get to earn a bit of interest on this money as well.

The nice thing about sinking funds is once you hit your goal, you can stop saving for that particular item. For example, if you need $1,000 in your technology fund to replace your laptop and you hit that $1,000 mark, you can stop saving for the laptop.

If you own a home, there’s always something that needs to be done. You may want to add more insulation, paint the inside or outside, add a deck, or remodel a bathroom. If you are like us, there’s always a wish list of things we want to do to the house. A sinking fund helps us get ready to do those things with no negative impact to our budget.

We highly recommend setting up a sinking fund for a yearly family vacation, including travel, meals, and attractions.

Another great example of a sinking fund is back to school shopping. The kids need new pants, shirts, socks underwear and shoes. If you live up North they may also need coats, hats, boots, and gloves. Then there are all the “must buy” lists that the teachers send home. Most of those lists have a long inventory of things for each child to bring to school

And there are additional school-related expenses for extra-curricular activities like band or field trips. A back to school sinking fund is a great way to keep all that school spending from breaking the bank.

The comprehensive list of every sinking fund you’ll ever need depends on your personal circumstances. One person may want to save for the vacation of a lifetime and someone else may just want enough cash to pay for Christmas.

If you haven’t been managing your money it will be a slow start because you can’t start putting money aside for Christmas and back to school and vacation and home renovations all at the same time. You’ll have to start slowly and build each sinking fund from the ground up.

Sinking funds are an excellent way to be a good steward of God’s money as they will move you from a reactive to a proactive position with your finances. You’ll be able to see the light at the end of the tunnel as you avoid future debt. Once you start using this method, success becomes easier and easier.

The Compass Catholic Podcast offers more on this topic.