It is difficult to cover significant expenses in a short time. Some people go into debt because of this. A well-established sinking fund helps protect against unexpected life events, protects your financial goals and contribute to better budgeting.
What is a sinking fund?
A sinking fund is a cash reserve in your account that holds calculated funds for future expenses. There is usually a separate account for each category of sinking fund. This account is separate from your regular checks, savings and emergency fund.
Your strategy should be to set aside a portion of your monthly income to allow the sinking fund to grow. The sinking fund you create can be either a set target amount for planned spending, or a general savings account for future unplanned but necessary spending.
sinking fund vs. emergency fund
A sinking fund may sound like an emergency fund, but it’s not. They have two separate structures. The emergency fund is a general fund, while the sinking fund is categorized as an expense.
The emergency fund is your last resort; so you don’t dig into it until you exhaust all your resources. It covers unexpected expenses that you never expected, such as loss source of income and need survive for months without a job.
Sinking fund expenses are predetermined or assumed, i.e. savings for a vacation, a down payment on a house, a down payment on a car, or home repairs. Amortization funds serve as a cushion for the reserve fund.
What is the purpose of a sinking fund?
The purpose of a sinking fund is to have enough liquid cash savings to cover estimated costs. The sinking fund supports expenses related to life events and assets.
Below are some of the reasons why you need to set up a sinking fund.
Coverage of planned expenses
Planned expenses can be as small as buying a gift or spending Christmas, or as big as a family vacation or buying furniture. Without flooding funds, these expenses will be paid from your checking account. However, using one account to pay for all expenses is never smart.
An amortization fund created for each planned expense helps to optimize the budget. Knowing where money comes from when you need it provides financial security and peace of mind. The sinking fund keeps cash on a monthly basis or two week savings prepare for future planned expenses.
Covering unplanned but expected expenses
Medical bills, home, car repairs and maintenance are expected but unplanned expenses. While you can’t set an exact budget for these things, planning them is essential.
An amortization fund created for unplanned but expected expenses helps prevent them from occurring in an emergency. Unexpected expenses quietly eat into our savings. The sinking fund helps offset the budget deficit.
Protect emergency fund
We have created reserve funds, hoping that we will never have to use them. The rainy day fund will take care of unforeseen life events. You never expected to lose your job, but it’s not uncommon. The COVID-19 pandemic forced 114 million people will lose their jobs over 2020.
A well-planned sinking fund helps protect against the changing circumstances of life. This prevents them from turning into a financial crisis. You can set up a sinking fund for items that could have a catastrophic impact on your budget and start accumulating cash reserves. The sinking fund will be ready to cover your expenses when needed.
Encourage the habit of budgeting
Setting up a sinking fund is a smart financial decision. This is a way of forward-thinking about financial responsibilities. By having a sinking fund, you save money for items you (may) need in the future. This is a good increase in the budget due to the repayment of funds.
You will create a sinking fund by transferring part of your earnings. You contribute to these funds every month and let them grow.
Avoid debt
At the Bank’s exchange rate as of July 2021 Emergency Rescue Survey51 percent of Americans don’t have three months of expenses saved in their emergency fund. Their last resort to cover expenses is to go into debt; no wonder that national debt exceeded $30 trillion.
A well-established sinking fund covers life’s unforeseen circumstances. You don’t have to come up with a significant amount of money in a short amount of time. This will protect you from getting into debt.
sinking fund categories
You can create a sinking fund for each event or expense. Therefore, it is always better to classify them by grouping small funds into one expense category. Sinking fund categories help organize savings and promote responsible spending if necessary.
Following are some categories of sinking funds.
Medical
American health care spending is on the rise. They spend about $12,500 on health care costs per person each year. Unexpected trip to the ambulance will cost you an average of $ 2,200.
The medical fund is needed to cover the costs of healthcare, dentistry and vision. A Health Savings Account (HSA) and a Flexible Spending Account (FSA) can act as your health fund. Contributions and deductions are not taxed. If you qualify for an HSA plan, you can also help grow money through investment.
car care
Americans spend an average of $397 a year on car maintenance and repair. While it doesn’t seem like a lot of money, a car replacement may be required.
Ownership car important to most Americans who cannot afford to lose the freedom that a car gives. It is advisable to create a fund that will take care of this important element. A car care amortization fund can cover regular maintenance, repairs, or a down payment on a car.
A car care sinking fund is essential if you can’t afford to go a day without a car.
home fund
Homeownership has always been the American dream. Home is your family’s sanctuary and you can’t miss a single day without the protection of your dreams. Depreciation fund for the house you can put money to buying a house. It could be an upfront payment, a closing cost, or anything related to a purchase. A home fund can save you money on future repairs and maintenance if you’re already a homeowner.
There are many benefits to owning a home, but it doesn’t come cheap. The cost of ownership can weigh you down if you can’t afford to cover the costs. For example, a regularly funded house cleaning fund can take the stress out of a major electrical appliance failure.
Children’s Fund
Average cost of having a baby ranges from $13,000 to $23,000. According to Consumer spending research in 2015, families spend an average of $233,610 raising children from birth to age 17. It would be unwise not to set up a fund to cover most, if not all, of the costs of raising a child.
Funds for a child may include preparation for pregnancy, childbirth, purchase of baby supplies, and funds for college education of children. You should look into the 529 Children’s College Plan, which has tax credits for education. Your HSA or FSA may cover health-related costs. For everything else, a separate fund should be created.
Miscellaneous funds
Another miscellaneous fund could be for vacations, holiday gifts, birthday parties, travel, or a wedding. You can set up a separate sinking fund for anything you deem essential and necessary. Some of these funds may be pooled or separate if this requires a significant outlay.
How to create a sinking fund?
Now that you understand that a sinking fund is needed, you need to set it up separately from your checking account. Follow the three steps below to create your sinking fund.
1. Determine how much you need and when you need it
The first step in creating a sinking fund is to determine the amount to be invested in it. This is the estimated amount you may need. You don’t need an exact amount, but a ballpark figure should be a good starting point. Use the average value in cases where it is impossible to determine the exact number.
Time is another important factor to consider when setting up a sinking fund. Scheduled events such as vacations or celebrations have exact dates when we need them. Expected events such as car and home repairs are not easy to predict based on their life cycle, but they can be expected.
2: Decide where to store funds
It matters where you place your sinking funds. These funds should be quickly and easily available when you need them. That being said, you don’t want to pay any fees for their service.
Internet banking ideal place to maintain a sinking fund. Most, if not all, online banks have no minimum balance requirements and no monthly fees. Internet banks offer more profitable savings and money market accounts with higher interest rates than regular conventional banks.
You can open as many accounts as you like. Choose any internet bank that is insured by the Federal Deposit Insurance Corporation (FDIC) to accumulate your sinking funds.
3: Determine how to save money
Determining how To save money for the redemption of funds depends on the type of fund, the level of income and how you receive income. The best way to create a sinking fund is to automatically transfer your income on a schedule. This can be once every two weeks or a month. Automatic translation guarantees the desire for savings.
The depreciation fund increases over time. The best way to build it is to save every month.
bottom line
Sinking funds set you up for financial protection. You are responsible for reporting these events, and the only way to protect your finances is to set up a proper sinking fund.
A sinking fund can help you in many ways, from minimizing your financial risk to supporting your financial planning. It only takes a few minutes to set up and automate, so you don’t have to think about it anymore. I encourage everyone to get started with the sinking fund.
