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Sinking funds can help you achieve your financial goals and reduce your money management stress. Find out how you can use sinking funds to improve your life and your finances.
What Is A Sinking Fund?
A sinking fund is a method of saving small amounts of money on a monthly basis in order to save for a large purchase or financial goal in the future. Using sinking funds can help you avoid dramatic spending increases, such as for the holidays or when large yearly costs come around. Instead of shelling out hundreds or thousands of dollars in one month, you can save a small amount each month.
This saving strategy might sound complicated at first, but many people actually claim that it has simplified their spending because they know exactly how much they have saved for different purposes.
For example, imagine someone who transfers an amount to their savings account each month based on the amount leftover after expenses. Not only are their savings not a priority, but the purpose of their savings is unclear. They might be thinking they are saving for a new car, their emergency fund, and several other expenses, but it’s all mixed together and with no goals in sight.
On the other hand, someone who uses sinking funds allocates a specific amount each month to several separate funds. They utilize SMART goals and are able to measure their progress each month. When the time comes to use one of their sinking funds, they have achieved their savings goal and they know the exact amount they have saved. Doesn’t that sound ideal?
How To Use Sinking Funds In Your Budget
The easiest way to budget for various sinking funds is to use a zero-based budget. This method gives every dollar of income a purpose, including expenses, sinking funds and debt repayment.
First, consider the different sinking funds you want to have. You can include any large expense that you want to save for over time. Think about holiday shopping and vacations, as well as saving for your financial goals. This might include a down payment for a mortgage or auto loan, home renovations, or simply yearly insurance or taxes. Whatever your savings goal is, you can create a sinking fund for it.
Next, estimate how much you need to save and how many months until you need the money. Use our simple sinking fund calculator below to find out how much you need to save each month:
Now for each sinking fund you decide on, add the monthly contribution to your sinking fund to your zero-based budget or other budgeting method you use. If your expenses are more than your income, find ways to cut expenses and re-evaluate your spending habits. Learn more about using a zero-based budget in our article, Make A Zero-Based Budget & Save 18% More Money.
Learn about different types of bank accounts to find the right one for your lifestyle to help you reach your financial goals.
How To Separate Your Sinking Funds Within Your Savings
Unless you separate your sinking funds, you’ll have to manually track how much you have saved for each purpose. This is time consuming and there are easier methods of utilizing sinking funds. There are several ways of keeping your sinking funds separate, so it’s best to learn about your options.
Some people still use the envelope method and put cash in envelopes for different sinking funds. If this works for you, then that’s great. But we recommend a more modern approach that actually enables you to accumulate interest on your savings. It’s also more motivating to be able to check the progress of your sinking funds at any time if you use a more advanced method.
Multiple Savings Account Method
The easier and more efficient route is using multiple, high-yield savings accounts. One option that we found highly recommended in our research is Capital One 360 Performance Savings account. From our research, it’s the only savings account that enables you to essentially have multiple savings accounts in one. It actually allows up to 25 savings accounts with their own savings goals. This means that you can have separate savings accounts for each of your sinking funds, but with the convenience of one account. According to their site there are no fees, no minimums and it is a high-yield savings account, although there are more competitive options.
Single Savings Account Method
There are other online savings accounts that offer higher interest rates, but without the same convenient features. One option is CIT Bank that currently (at the time this article was published) offers a savings account with a higher interest rate than Capital One. The downside is that you’ll have to either open multiple savings accounts with CIT or keep track of multiple sinking funds on your own.
Keep in mind that like most high-yield savings accounts, both previously mentioned have interest rates that are variable and can change often.
Make Your Savings Automatic
Whatever method you decide on, try to make your monthly contributions to your sinking funds automatic. This way you minimize the chances that you miss a month. Taking a few minutes to set up a recurring transfer will save you time and stress down the road and set you up for success.
Achieve Your Financial Goals With Sinking Funds
The bottom line is that by saving each month you can achieve your financial goals and your life goals more efficiently. Reduce your holiday shopping stress by setting a limit and saving each month. Buy the car you’ve been eyeing by saving each month. Get closer to your dreams of owning a house one month at a time. All of this is possible by using sinking funds, you just have to get started.
Financial freedom begins with good habits.Rebecca & Tiago, theloadedpig.com