(SINK) [v. sank (sngk) or sunk (sngk), sunk, sink·ing, sinks]
1. To descend to the bottom; submerge.
2. To fall or drop to a lower level, especially to go down slowly or in stages: The water in the lake sank several feet during the long, dry summer.
3. To subside or settle gradually, as a massive or weighty structure.
4. To appear to move downward, as the sun or moon in setting.
5. To slope downward; incline.
6. To pass into a specified condition: She sank into a deep sleep.
What is a sinking fund in financial terms? First of all, it’s quite possibly the worst name for any financial term. It was first used in Britain in the 18th century to help repay the national debt.
What does it mean in current day? For businesses and families it means something completely different. I won’t go too deep into the business aspects because it has to do with bonds, debt repayment, credit risk and other really complicated things that make most people’s head hurt just thinking about it.
For PERSONAL finance, it means something much different. A sinking fund is a way to save up and pay for something (usually a large item) that you know will need to be purchased in a set amount of time.
Let’s do some examples, because I like puppies. (just checking to see if you’re actually reading, or just skimming my articles… leave me a comment below if you’re actually reading).
You bought a beautiful home that is twenty years old. When you bought your home you had a home inspection and the inspector told you that you’ve got about 5 years left on your roof. You’ve lived in your home for a year and you start seeing several of your neighbors (with homes about the same age as yours) replacing their roofs.
When you take back the lawn mower you borrowed from your neighbor you casually ask what they paid for their new roof. He answers…. $6,000! SIX GRAND?! Does the roof also shoot lasers into the air at night and put on a light show for your kids? No? It just keeps the rain out? Wow that’s a lot of money (this is also a great reason that you don’t move into a house when you’re broke… because homes need roofs… surprise!).
You talk to a roofer friend (because everyone has a roofer friend, right?) and they tell you that your roof will last through next year, MAYBE two years. He says that it’ll be around $5,500 for yours, and it’s $9,500 for the laser-night-light-show option (if you have the means, I highly recommend picking one up).
So you need to save $5,500 over the next 12-24 months. (Let’s assume you’re out of debt. Because if you’re not out of debt, you’re not going to be putting on a roof. You’re going to patch it with some tar and some extra shingles until you’re out of debt and can start saving.) If you want to put the roof on next year, you’re going to need to save around $450/month into a SINKING FUND.
Just think of it this way, if your house fills up with water because you didn’t replace the roof, you’ll be “sinking.” (That’s the best connection I can make to this term.) If you want to replace it in two years, you’ll need to save around $230/month until you have enough.
Or maybe you want to spend $900 on Christmas presents for your family, and woah… it’s October. You’re going to need to set aside $300/month for the next three months.
What are some of the “big” items that you might need a sinking fund for? Any big purchases that you can anticipate. These aren’t emergencies. That’s what your emergency fund is for. Here are some big ticket items that you might want to plan for:
- Major home repairs
- Car repairs (tires, etc)
- New car purchase
- New Carpet
- Gifts/fun events (Christmas, Birthday Parties, etc)
That’s just a quick list… Leave a comment below to let me know (and help others!!) what you are (or should be) saving for.
Anticipating what you might need to spend money on is a great way to keep yourself out of debt. If you’re not adequately prepared to make a purchase (meaning you don’t have CASH), then you justify putting a new washing machine on a credit card…. and you have to buy the matching dryer right? They’re like brother and sister. You can’t break up the brother and sister, right?
Or, if you didn’t have the money and your washer died, then maybe you spend $200 from your emergency fund to get it fixed, then first replace that $200 and start saving for a new washer. That way you’ll have a working washing machine, and you won’t go in debt to replace it. If you want to get the matching washing machine/dryer, then you need to save $1,200-$2,000. How fast do you want it? 6 Months? we’ll, then you’re putting away $200-$350/month until you have enough.
The concept overall is simple…. save up money and pay for things rather than borrowing to pay for them. Follow that simple principle in your life and you’ll live a very happy and financially fruitful life.