The Sinking Funds Phenomenon
First, let me be fully transparent here and confess that I have many sinking funds. Probably more than most people. I started using sinking funds about 3 years ago and it has evolved significantly in that time. I don’t proclaim to be an expert about this budgeting tool.
But I do know this: Sinking funds have changed my financial life.
So, what is a sinking fund?
Essentially, a sinking fund is a pool of money you make regular contributions towards to save money for a specific category or item. It is about planning for expenses you know will come up in the future. You could use a sinking fund for an expense that happens regularly, like pet care. Or it could be saving towards a one-time occasion, such as a holiday to Europe.
Sinking funds can be done electronically (through your bank, an app, a spreadsheet) or it can be done using cash envelopes.
The simplest way to explain this concept is to imagine Christmas.
Everyone knows that Christmas comes on the 25th of December every single year. Christmas does not knock on our door in March or in August shouting “Surprise! I decided to come early this year!”
Why then, is it common for people to feel the financial shock in the aftermath of Christmas?
After the shopping and the gift-giving and the festivities are over, and after the Christmas tree with all its shiny baubles has been taken down, many people face their credit card bills with a feeling of dismay.
The good news is we can turn the feeling of dismay into one of enjoyable reflection and peace. Christmas is the perfect way to introduce sinking funds into your life.
Let’s look at the steps to create a Christmas sinking fund.
Write down all Christmas-related costs making sure you cover everything (note to self: must include new outfits for the school concert)
Tally all items to find out the total cost
Work out what month you need the money
Divide the total by the number of weeks/months
Allocate the amount in step 4 to your sinking fund each week/month
We’ll use these steps to go through an example.
Let’s say my total cost for Christmas comes out at $2,000. As we are at the start of June and I would like the money saved by 1st December, I have 6 months to complete my Christmas sinking fund.
$2,000 divided by 6 = $333.33 per month
Because I am paid fortnightly, my plan is to work out how many pays I have left from now until 1st December. I have calculated I have 13 pays left.
$2,000 divided by 13 = $153.84 per fortnight
Now I don’t need to worry about the costs that arise around Christmas as I have planned ahead of time. My $2,000 will be ready and available come December.
The earlier you start saving towards a sinking fund, the more you can smooth out the spending. With the $2,000 Christmas sinking fund example, if I had started saving in January I would have another 10 pays.
$2,000 divided by 23 = $86.95 per fortnight
Voila! My Christmas sinking fund is in operation!
I have successfully used sinking funds for most situations and it has been life changing. And I mean this whole-heartedly. It is not an exaggeration.
Not everyone will appreciate working their finances down to this level and that’s completely fine. Sinking funds are just one approach.
Some may wish to have a large savings account where all money goes. That’s completely fine too. As long as money is going in and staying in. It would be pointless to have a large savings account that you spend regularly from as it then becomes difficult to track whether you will have enough for all of life’s expenses.
There is no ideal number of sinking funds a person can have. What works for me will definitely not work for everyone.
I encourage everyone to give it a try. Just start with one. Especially if you tend to struggle with managing life’s expenses.
The use of sinking funds can alleviate the need to rely on credit cards as a crutch.
Sinking funds helped bring me financial peace. I hope they do the same for you.