Why Sinking Funds Are Your Ticket Buying Anything You Really Want!
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One of my family’s favorite things to do is to go to on vacations! A weekend at the beach, a trip to Walt Disney World, or wherever. We can do it even though we’re certainly not rich, and no, we don’t go into debt for it either! Read on to learn how you too can take your family (almost) anywhere that you want to go through the magic of saving money with sinking funds!
What is a Sinking Fund?
Budgets are great! You are telling your money where to go, and not wondering where it went (Dave Ramsey is credited with this little truth nugget). Yet, many people forget about the random, one-off purchases. As when you find that you need to buy soccer shoes for your son, there goes your spending budget! Ruined! Stink! Yeah, “stink” is my cuss word of choice these days, as three-year-olds are great at parroting.
Insert the sinking fund, the answer to your problem and one of the best ways to save money!
A sinking fund is a strategic method of saving money for a specific expense. For example – vacation, house repainting, car fund, kid’s activities, kitchen remodel, etc. The process is to identify a goal, assign it a dollar amount, decide the date of when you need it, and divide the total by the number of months left until the due date and start saving money for it!
You can go on great vacations! You just have to save for them first!
Example: Your son, Alex needs $240 for this season’s soccer fees, uniform, and pictures. Soccer starts in 5 months. So…
$240 / 6 months = $40 a month you need to save into your sinking fund for “kids activities”
Then come soccer season you already have the money for all the expenses! Sinking Funds are the next level of the pay yourself first model. As you should have your emergency fund in place and are contributing 15% of your gross income to your retirement accounts then go for sinking funds.
RELATED: The Most Important Strategy to Help You Build Wealth: Paying yourself first is the key to always saving money every month, without fail!
How to Set Up a Sinking Fund
If your sinking fund is a one-off, type thing (i.e., a fun yoga class) a cash envelope system will work well. I use a cash envelope for my Christmas spending money. If the sinking fund is an ongoing expense such as vacations, then consider opening up a separate checking account to hold this money. And YES, the funds must be kept separate, so there is never any confusion about what your $$$ is for.
My bank allows us to have multiple checking accounts without fees. Please check with your bank on any qualifiers that you need to meet in order to have multiple free checking accounts. You can easily get free accounts, so don’t settle if your current bank doesn’t offer it, look around for a better bank! Nerdwallet has a great post about the best banks with free checking accounts.
Don’t use savings accounts for this purpose. As a federal rule called Regulation D has put a six transaction limit on how many transactions per month you can do in & out of a savings account fee free. It’s this way for all banks, for all savings accounts.
Let’s say that you’ve decided that your kids always have stuff going on. So you need a permanent account, now you’ve opened a checking account (Yaaaa you!) One of the best things that you can do is to name that account “Kids”. Seriously, go into your account settings and edit the name of the account to read “Kids”. It sounds silly, but the psychology on giving things an exact name absolutely works. I have an account for my kiddo, and I could never (ever) go into that account and borrow money from it, other than for its intended use. My conscience would never allow that to fly. That account is safe.
Still not quite sure what you’d need a sinking account for? Check out my list of the most commonly missed budget expenses, and be sure that you are covering everything!
How to Fund Your Sinking Fund Account
A good rule is to start planning six months out for an event, but if the item is a large dollar amount consider nine months. This way you’re not trying to save for “everything” all at once.
As you look ahead at expenses, start giving them a dollar amount and adding them into the tally. Since this is an ever revolving account new money will flow in, and saved money will flow out. (i.e., birthday party expenses, braces, back to school clothes, school pictures, sports fees, summer camps, etc.).
A good tip is to go back through your previous bank/credit card statements and see what kind of one-off purchases there have been. Do you have enough of one type of purchase to necessitate its own category sinking fund?
The Minimalist Approach to Sinking Funds
If your brain is exploding with thinking of “all the things” you could have a sinking account for then let’s make this super easy on you! I am an aspiring Minimalist, and personally, my brain got a bit overwhelmed with all the possible expenses. So we pared it down and do it the way I am about to describe to you.
Think of a sinking fund category that you want, add up a year’s worth of expenses, and then divide by 12. Set up an automatic deposit for that same amount every month. Done. Easy. Maybe start an account with a decent balance (say $100) from your upcoming tax return or funds from a garage sale. That way you’re primed if something comes up earlier than anticipated.
My family has multiple sinking funds for holding our saved money, each with their own checking account…
- Vacation fund: aka my happy place fund! This is where we save on everyday things to splurge on what we really want. Because we decided that getting away as a family is important to us. You can have an entirely different “save to splurge” account, it’s okay whatever it is. Just so long as you plan for it!
- House fund: all large purchases such as new furniture, HVAC services, large tree limb pruning service, carpet cleaning, etc
- car fund: car insurance, oil changes, car repairs, new tires
- Kiddo fund: all her medical costs (our three-year-old has Cerebral Palsy, so her expenses are considerable even with health insurance). Also, a new set of clothes each spring and fall (as kiddos grow fast!), etc. In the graphic below this is the “ABLE” account, it’s similar to a college savings 529 account, but it can be used for more things that just college (i.e. medical needs).
- We each also have our own personal savings, where 5% of each of our paycheck goes immediately into there. This is our extra fun money, I use this account to save for splurges.
We used to have a sinking fund for emergency savings, but once we hit six months of living expenses, we stopped contributing. So it just holds steady, and we disperse that money to other areas.
I also use cash envelopes for my Christmas Spending money; come January week one, I start with $20 saved each week. Come November I buy a prepaid credit card, and then use that for all my holiday shopping (as I do a decent bit online). I also use cash envelopes for large, one off the purchases for things that I personally want.
Common Mistakes of Having Multiple Accounts and How to Sidestep
If you have the habit of all too easily transferring money back and forth into accounts, maybe consider opening an account at a separate establishment. That way, you don’t see it on your regular banking interface. For example; my family’s Emergency Fund is in a savings account at Ally Bank, I never actually see this money on banking screens, it’s entirely separate.
One of the great things about having an Ally savings account for our Emergency Fund is that it earns a MUCH HIGHER interest there than it would at our regular bank. Every day banks typically offer horrible interest rates on savings accounts, like .08% APY, while some even go as low as .01%. While Ally is now offering 2.2% (as of March 2019), yet this could change at any time).
For example, if you had a $30,000 emergency fund. In one year at a regular bank with a savings account of .08% APY you’d earn $24. While at Ally, with 2.20% you’d earn $660.
Ally bank is so consistent with their returns, service, and features that Money Magazine rated them the Best Online Bank of 2018 (source) Oh, and $0 service fees on both checking and savings accounts.
My Family’s Pay Yourself First Payment Structure into Sinking Funds
If you want to see how I manage our family’s sinking funds here it is, and I’ve done it this way for 4+ years, so I know this works!
At the end of the month
When I reconcile bills at the end of the month, I look at our credit card statement and tally up any expenses for our sinking fund accounts. Then I transfer money out of those accounts, into our main account, and then I pay the cc bill out of that main account.
It may seem like an odd way to save money, maybe bit clunky at first (as anything new takes a bit of getting used to). But this process of an entire month’s bill pay probably takes 30 minutes, one time a month. That’s it!
So what’s your favorite sinking fund account? Is it a Save to Splurge type? Let me know in the comments below!
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