Why you need a sinking fund… Oh, and what is a sinking fund?

Why you need a sinking fund… Oh, and what is a sinking fund?

Sinking Fund

 

(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.

Why You Need a Sinking FundFor 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:

  • Vacations
  • Major home repairs
  • Car repairs (tires, etc)
  • New car purchase
  • Furniture
  • Appliances
  • 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.

12 Responses to Why you need a sinking fund… Oh, and what is a sinking fund?

  1. Kevin E says:

    We also do this for smaller things like professional organization dues, vehicle registrations (that was an unexpected $300 this year), and vet bills. The longer we track our spending, the better chance we’ll catch these hurdles before they touch our emergency fund.

  2. Mitch says:

    We create a sinking fund for Christmas, haircuts, pet needs and let’s not forget taxes. Yes taxes. What? You don’t pay taxes. Leave your comment below and I’m sure someone will get ahold of you.

  3. Chelsea says:

    We have lots of sinking funds…haircuts, Xmas, license renewals, new furniture, home repairs, car repairs, new car fund, new phone fund, the list goes on. And we will be debt free (except house) by the end of the year!!

  4. Sam says:

    Not that i have ever had the opportunity to buy a new car, but i know if you walk in a dealership with cash in hand, you have huge buying power so you can negotiate a hell of a price, and save money on interest. Win, win.

    • Ben Miller says:

      CASH IS KING… EVERY TIME. Car dealerships are a little more difficult since they make SO much of their profit from leases and kickbacks from the loan payments. But smaller, used car dealerships are just trying to move CARS. Go somewhere that you can talk with the OWNER of the dealership and you’re going to get a GREAT deal! CASH CASH CASH!!!

      (Then, after you buy your car, save up a “car payment” every month for a year, and you’ll have another $3-5K that you can sell your current car and move up into a better car by $5K!… Keep doing that and you’ll have a really nice car with NO PAYMENTS!)

  5. lori dunagan says:

    If your appliances do need repair u can find great how to videos on the web that will visually show u how to diagnose and repair. Its saved us a lot of money and can help until u have saved enough for a new one.

    • Ben Miller says:

      Lori… YouTube is a GREAT option versus replacing something! We had our dryer go out, and it turned out that it was being run without the filter for a few loads and a sock got caught down in the trap. I found a video explaining exactly how to take it apart and fix it! In the end, I only had 4 extra screws when I put it back together, so I figure that’s a win!

  6. Greg says:

    This is a great idea, and doesn’t only have to be for tangible items…what about a fund for investing (separate from your 401K)

    • Ben Miller says:

      Greg, you could technically do this with investing by backing out a number that you want to be at in ____ number of years. So, if you wanted to have a million dollars in 30 years, you would have to invest $300/month for those 30 years.

      The sinking fund is usually for shorter purchases (or things you know you’re going to need to buy or replace), but the same math applies!

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