When sticking to a budget, our biggest priority after paying for fixed expenses is to contribute to a Sinking Fund. This is because sinking funds stop us from going into our emergency funds or acquiring more debt.
In this post, we’re going to explain what a Sinking Fund is and how we use them.
What are Sinking Funds?
We like to think of sinking funds as lifeboats on a sinking ship. All is going well, you are sailing along quite happily on your debt free journey, your budget is running smoothly when BAM! Suddenly, you hit a financial iceberg. That iceberg may be a broken-down car, school uniform costs, or whatever the case may be.
Sinking funds take away that panic of hitting that financial iceberg so you aren’t left worrying about covering that expense. We know these things will happen at some point. It’s unheard of for you to buy a car and never spend a single penny on it and then sell it 10 years later. All cars need money spent on them, whether expected or unexpected.
What is a sinking fund used for?
There are no set rules for what you should use a sinking fund for, but a few examples are:
- Christmas – It’s the same day every year, plan for it!
- Birthdays – Like Christmas, birthdays are the same day
- School Uniform Costs
- Car Maintenance/M.O.T
- Pet Expenses
- Home Repairs
How to calculate sinking fund
To calculate a sinking fund, you should:
- List the things you will likely need a pot for,
- Calculate how much you’ll need for each fund
- Divide this figure by 12 and save that amount every month.
Sinking fund calculation example
If you’ll need £250 a year for car maintenance, you’ll divide that by 12 (approx. £20.80) and save that amount every month throughout the year.
Where that may not work is when you’ve only just started a sinking fund and you have a shorter time to save for expenses. For example, it’s September and you don’t have a sinking fund for Christmas, or is August and you haven’t one for school uniform costs.
In these scenarios, you should calculate the bare minimum you can get away with spending for each item and save for that first. It may mean changing your lifestyle or having to scale back significantly on Christmas for example. If you are still struggling, you may need to re-write your budget.
Where do you keep your sinking funds?
It’s up to you! We keep ours in a separate bank account and transfer money to it every month. Due to the current low-interest rates, we just have them in an easy-access savings account that we can withdraw from quickly when I need to.
I know of some people who keep their sinking funds in cash in their house. If you are going to do this, I highly recommend checking with your house/contents insurance to see how much would be covered by them in the event of an emergency (fire, robbery, etc).
James Banerjee is an Account Director who graduated from the University of Kent in 2014. He works in SEO on clients such as HSBC UK and Nestle and he has a keen interest in personal finances and money-saving advice.