Sinking funds are an essential financial tool that can help you achieve your long-term financial goals. They are a simple concept, but one that can make a significant difference in your financial well-being over time.
In this blog, we’ll discuss what sinking funds are, why we recommend them, how to build them, the difference between sinking funds and other saving accounts, and how you can use them to achieve your financial goals.
What Are Sinking Funds?
A sinking fund is a type of savings account that is specifically designated for a particular purpose or event. This can be anything from saving for a down payment on a house, paying for a kid’s college education, saving for a bathroom renovation, or even preparing for unexpected expenses like needing to buy a new car.
The idea behind a sinking fund is to set aside money regularly, over a period of time, so that when the time comes to use that money, it’s already available and waiting for you.
Why You Need A Sinking Fund
There are several reasons why sinking funds are a useful financial tool. Here are some of the most important:
- They help you plan for the future: Sinking funds help you anticipate future expenses and plan for them ahead of time. This can reduce stress and financial uncertainty, knowing that you have the money set aside to cover any upcoming expenses.
- They promote financial discipline: By setting aside a specific amount of money each month, sinking funds help you develop the habit of saving regularly. This can help you build a strong financial foundation and avoid the temptation to overspend.
- They can save you money in the long run: By saving up for larger expenses over time, you can avoid taking on debt or dipping into emergency funds. This can save you money on interest payments and other fees over the long run.
- They provide peace of mind: Knowing that you have money set aside for specific expenses can provide a sense of security and peace of mind. This can reduce financial stress and help you sleep better at night.
How To Build A Sinking Fund
Sinking funds work by setting aside a specific amount of money each month or each pay period, into a separate account. This account is typically a savings account, but it can also be a brokerage account or another type of investment account.
The amount you set aside each month will depend on the size of the expense you\’re saving for and the timeframe in which you want to save. For example, if you pay $400 every 3 months for waste management, you can set aside $133.33 each month versus needing to have $400 ready each quarter.
Once you\’ve set up your sinking fund, you can automate the process of setting aside money each month. This makes it easier to save consistently and avoid the temptation to spend the money elsewhere.
Sinking Fund vs. Savings Account vs. Emergency Fund
While sinking funds, savings accounts, and emergency funds may seem similar, they each serve a unique purpose and are designed to meet different financial needs.
Sinking Funds: As we discussed earlier, sinking funds are a type of savings account that is specifically designated for a particular purpose or event.
Savings Accounts: A savings account is a type of bank account that is designed to help you save money over time – there is no specific goal in mind for it.
Emergency Funds: An emergency fund is a type of savings account that is designed to help you cover unexpected expenses, such as a job loss, medical emergency, or car repair.
The key differences between sinking funds, savings accounts, and emergency funds are as follows:
- Purpose: Sinking funds are intended for a specific future expense, while savings accounts are more general and can be used for any expense. Emergency funds are intended to cover unexpected expenses.
- Timeframe: Sinking funds are typically set up over a specific period, while savings accounts and emergency funds can be ongoing.
- Use: Sinking funds and savings accounts are intended to be used for planned expenses, while emergency funds are intended to provide a financial safety net in case of unexpected expenses.
- Access: Sinking funds and savings accounts are usually easily accessible, while emergency funds may be kept in a separate account or invested in a way that makes it less accessible but more likely to earn a higher rate of return.
By understanding the differences between these financial tools, you can make informed decisions about how to manage your money effectively and achieve your financial goals.
The Bottom Line
Sinking funds are a simple but powerful financial tool that can help you achieve your long-term financial goals. By setting aside money regularly for specific expenses, you can plan for the future, promote financial discipline, and save money in the long run. If you’re not already using sinking funds, consider starting today – your future self will thank you.