Sinking Funds, A New Way to Save

Most people have never heard of a sinking fund. Typically you start with a savings account. Next, you add a checking account which is typically used to pay bills and other expenses. Savings accounts often serve as an emergency fund that is rarely touched. Others use it as a revolving account where money is often removed and then, hopefully, returned.

Having only one account can stop you from building up savings. Usually, if a person only has one savings account, they are more likely to dip into the account for things other than emergencies.

For example, after accumulating $50,000 in a savings account, it doesn’t seem like a big deal to take $100 out to buy another pair of shoes. You also may overspend throughout the month, knowing there are savings to fall back on.

How to Use Multiple Savings Accounts

Consider creating multiple savings accounts instead of keeping your savings as a lump sum in one savings account.

For example:

• Emergency Fund
• Christmas Fund
• Vacation Fund
• Large “named’ Purchase Fund (maybe “Down payment Fund” or “Wedding Fund”)

By separating your savings and putting a name on each account, you are less likely to remove funds unnecessarily. If you have money saved in a vacation fund, you’re less likely to buy a $100 pair of shoes, for example. When you look at your bank account to transfer that $100 from savings to checking, you see it labeled “vacation fund.” It makes you think twice about buying a new pair of shoes when you really want to save for a vacation.

What is a Sinking Fund? 

Just separating your savings account and naming them can make a huge difference for your savings and spending habits. To maximize your savings, you can use these savings accounts as “sinking funds.” A sinking fund is simply a savings account that you save into regularly.

Have you ever looked at your credit card statement in January and cringed because of overspending on Christmas presents? A sinking fund is a great way to avoid a large credit card bill and potentially a lot of interest! It also works for large expenses like purchasing furniture or paying for a wedding.

Do you remember the adage “pay yourself first”? You can do this with a sinking fund. You pay into each savings account monthly or even when each paycheck gets deposited.

Not only are you paying yourself first, but you are regularly saving up for bigger purchases.

If you use a sinking fund, you are much less likely to go into debt for large purchases because you already have your budgeted amount saved up and ready to use.

Is it perfect? No. Will you still overspend sometimes? Possibly. But, if you do overspend, it’s still nowhere near the amount you would have charged to your credit card without the savings account.

Plus, you are reducing your potential debt and the amount of interest you will pay in the long run and earning some interest on your savings simultaneously!

How to Prepare Yourself to Save Smarter 

Here is a little exercise for you to do right now.

• Look over your budget. Don’t have one? (Check out this post on how to create one.) Your budget helps determine your excess income each month and how much is available to save.
• Write down any large expenses you have that you are not currently saving for.
• Open additional savings accounts and create a name for each account to reflect what you are saving for.
• Figure out approximately how much you’ll need for each expense and when you’ll need it to be available to spend.
• Divide out the total you need by the number of contributions you can make and set it up to contribute that amount.
• Re-evaluate as needed.

Using a Sinking Fund in Practice

Let’s look at an example:

Mary wants to start saving more intentionally and stop dipping into her savings for unexpected expenses that pop up.

• She has looked over her budget and now knows that she has $500/month available at the end of the month after she pays her bills.
• Mary wants to save for the holidays and vacation. She also wants to pay her auto insurance semi-annually, saving her some extra money versus paying monthly.
• Mary opens three savings accounts in addition to her emergency savings account:
  • Christmas
  • Vacation
  • Auto insurance.
• Mary needs $500 for Christmas, and it’s ten months away. She needs $1200 for vacation, and it’s six months away. Finally, Mary needs $500 in 4 months to pay her auto insurance in full for the next six months (She’s been paying $100/month, but she gets a discount for paying semi-annually, so she’s already saved $100 right away)!
• She starts contributing $50/month into her Christmas club savings, $200/month into her vacation savings, and $125/month into her auto insurance savings.
• At the beginning of next year, she re-evaluates and realizes that she can go on a more expensive vacation (or take two trips)! She’s still contributing the same amount; however, she kept saving into her vacation fund even after going on her trip last year, so the balance has continued to grow. Mary can also reduce her Christmas club account contribution because she started saving earlier and didn’t spend all the money from last year.

In this example, Mary still has money left over, even after contributing to her sinking funds. She can either allocate that excess to one of her sinking funds, put it into her emergency fund, or spend it! Mary doesn’t have to spend all the money in the savings account at once, and she could use the excess either as a cushion or rollover to the next time the expense occurs.

Reach your Savings Goals this Year with a Sinking Fund  

Consider your larger expenses and how you can utilize a sinking fund (or multiple funds) to help you meet your goals each year!

Remember, if you have any financial questions, I am happy to help you navigate your unique path to reaching the goals that are important to you.

Nichole M. Coyle,
CERTIFIED FINANCIAL PLANNER^TM
20333 Emerald Pkwy, Cleveland, OH 44135
216.621.4644 x1607

Securities and advisory services offered through Cetera Advisor Networks LLC, member FINRA/SIPC, a Broker-Dealer, and a Registered Investment Advisor. Cetera is not affiliated with the financial institution where investment services are offered or any other named entity. Investments are: Not FDIC/NCUSIF insured * May lose value * Not financial institution guaranteed * Not a deposit * Not insured by a federal government agency.

Posted In: Saving, Tips For Managing Finances