What Is a Sinking fund?
A sinking fund is money that you set aside for a specific purpose. You can set up a sinking fund for absolutely anything, no matter how large or small it may be. It is most useful in situations when you have a specific amount in mind to spend by a certain time period. For example, you can have a sinking fund to start saving for Christmas, birthdays, medical expenses, a car, or even vacations.
Having a specific goal is what sets a sinking fund apart from a traditional savings account. You know ahead of time exactly what you are saving for, and you have a time period in which to save those funds.
How Do You Set Up a Sinking Fund?
The first thing you need to do is determine the target amount to save. Once you have that amount set, determine how much time there is until you expect to spend those funds. From that point, you will know how much to save each month or paycheck to accomplish your goal.
For me, I planned to take a vacation during the Fall season. I planned to save $1,000 to cover the room, food, entertainment, and gas. Once I knew how much money I was aiming to save, I was able to calculate how much time I had until the vacation started.
I had four months to save when I initially set up my sinking fund. That is eight pay periods because I get paid bi-weekly. Let’s do the math together:
$1,000 ÷ 4 months = $250 per month
$1,000 ÷ 8 pay periods = $125 per paycheck
Once you do the math for any goal, you can adjust the parameters to help you reach that goal. For instance, if $125 felt like too much to save per paycheck, I could extend the end date another month or reduce the amount I planned to save and spend.
Benefits of a Sinking Fund
There are several benefits to planning your spending this way and creating a sinking fund.
1. It Is Controlled — It allows you to save and spend within a budget. You can set a feasible goal that works for you. This helps to eliminate overspending and helps you live within your means.
2. It Saves Money — Since you save what you need prior to spending it, you avoid the interest charges you would accrue using a loan or credit card.
3. You Have Guilt-Free Spending — Once you reach your savings goal, you can spend that money guilt-free. You worked hard, saved, sacrificed, and budgeted, so now you can enjoy the results of that hard work and be proud of how you managed your money!