Sinking funds are used to pay for large expenses that are planned. You may use different sinking funds to pay for home repairs, save for a new car, pay for your vacation or to cover large medical bills. By setting the money aside before you use it, you will avoid using your emergency fund unnecessarily, as well as give yourself more negotiating power when it is time to purchase. Some businesses also use the term sinking funds for planned expenses.
When it comes to personal finances, sinking funds offer a great way to plan for your future and to make sure you can reach the goals that you set for yourself.
When Should I Use Sinking Funds?
There are a number of different reasons and ways to use your sinking funds. If you have a planned expense or an annual expense, you can set up a sinking fund for it. Things like your vacation, home remodeling, and taxes could all have sinking funds for them. Even if you do not know the exact costs, you can set up a sinking fund for them. For example, you can set up a sinking fund to cover medical expenses.
When you set up your sinking funds, you will need to decide on how much you need in each fund. Then divide that amount by the number of months you have until you make the purchase. Finally you add these amounts into your budget. If the sinking fund is for something like car repairs or medical expenses, you may want to determine how much you would like to have in the fund.
You can set aside the money until you reach that amount. then you can stop until you use money in the fund. Then you can replenish the amount as needed
What Types of Accounts Should I Use for My Sinking Funds?
You should keep your sinking funds in fairly liquid accounts; a high interest rate money market account would be ideal.
The account also depends on what the fund is for, if you are working toward a larger goal, you may be able to put into a fund that is not as accessible but that would have a higher yield. However, you should not put your sinking funds into stocks or in the market. If you want to earn a higher interest on your sinking funds consider putting them in an online savings account that offers a higher interest rate than your local bank does.
You may choose to have a different savings account for your sinking funds depending on what you are doing with the sinking fund and how liquid you need the funds. For example, car repairs may happen at any time and that money needs to be accessible very quickly. Your down payment for a home does not need to be as liquid, since you will know in advance when you will need the funds. This may allow you to earn a higher rate of return on the money you are saving.
How Are Sinking Funds Different from Savings?
Sinking funds are different from your savings account. When it comes to savings, you are working to build wealth. As you build your savings, it will eventually begin to work for you. This is not money that you want to dip into. However with a sinking fund, you are saving up for your planned expense.
This means that you are saving with a goal for the specific money. This savings is not likely to increase your overall net worth, but it lets you do the things you want to do, like buy a new car, go on vacation or put a down payment on your home.
How Are Sinking Funds Different from Emergency Funds?
Sinking funds are designed specifically for planned expenses. For example, you would use it to replace your roof, if you know that you will need to replace it in five years. Another planned expense is a vacation. Another expense is a new pair of glasses, if you know that you get a new pair every year, you can plan for them. These are things you know about. An unexpected car repair would be covered by your emergency fund, whereas you would use a sinking fund to replace the tires, since you know that you will need to do it.
When you first begin budgeting, you may cover more expenses with your emergency fund, but as you being to budget you can track your expenses and recognize areas where you can set up a sinking fund. This can help you manage your money and focus on your financial goals. Some budgeting software can help you determine how much you save for each category.