What Is a Sinking Fund?

Budgeting for monthly expenses is usually pretty straight forward.  You have expenses that occur regularly every month, and many of them, such as a mortgage, insurance, and cell phone, are all the same amount every month.  These fit into the monthly budget fairly regularly and are easy to plan.  You know that you have a certain amount of income, and you know that you have regularly occurring expenses (usually of the same amount), and you pay them.  You have budgeted for food and household expenses that are fairly regular and predictable.  After paying yourself, of course, through regular savings, whatever is leftover you can budget into categories such as entertainment and "mad money."

But what about those expenses that only occur a few times throughout the year?  My bill for the trash removal is over $125 dollars but only occurs every four months, for example.  We usually owe on our income taxes, and that only occurs once a year.  Automobile registration in Colorado is kind of expensive, but that only occurs once a year per vehicle.  

Paying the entire amount for each large expense can really throw off the monthly budget when each of these large expenses is due.  So how do we budget for them?  

With something called a "Sinking Fund" which is where you can set aside money every month and be prepared for when these expenses actually occur.  By writing down these large expenses and then figuring out how much to set aside each month, you can easily save up and then have the money to pay them when they come due instead of having to worry about coming up with the money when each comes due.

Separate Account:

My very first recommendation is to have a completely separate account to putting money away and then using for paying these infrequent bills when they are due. For example, in addition to our regular checking account and a savings account, we have an additional checking account where we put money aside for these types of expenses.  The reason we prefer a checking account is because we can either write checks to pay a bill (for the odd entity that still takes checks), use a debit card, schedule an ACH payment, or schedule through our bank's bill pay system.  Being in the cyber-security biz, I just don't feel comfortable linking a savings account to another company's system for making payments.

Setting Up the Sinking Fund:

I mentioned using a separate checking account for the sinking fund.  When I first set up our own sinking fund, I funded it with an initial balance of about $1,000 dollars to pay for the first few expenses that occurred, then have a cushion while I build up the sinking fund with regular contributions.  Then, I listed all of my anticipated periodic expenses throughout the year, determined how often they were paid, then calculated the monthly expense for each.  By adding up all of the monthly equivalent expenses for each item, I was able to determine how much money I need to set aside to pay those bills when they come up.  I then use that amount as a regular monthly budget expense line-item.  When each bill comes due, I simply pay it out of the other checking account that I have setup specifically for sinking fund related items.

Periodic Expenses:

The types of expenses that I include in a sinking fund are those periodic expenses that occur throughout the year, and what I consider to be "maintenance expenses" in nature.  For example, automobile registrations, preventive maintenance, reserved for things like income taxes and mortgage escrow shortages, subscriptions, and regular doctor's visits.  They are my best estimates, based on previous spending.  

I don't use this sinking fund account to prepare for large emergencies.  For one thing, I have no idea when those emergencies will occur, and for another, because I like to use a higher interest-earning account to stash my emergency funds.  If you follow Dave Ramsey's "Baby Steps" for financial health, you will have $1,000 in an initial emergency fund, and then three to six month's expenses in a larger emergency fund.  I use a savings account for both so as to have liquid funds, and my bank gives me a better interest rate as long as I keep a minimum balance in that account.

Saving For a Purchase:

This is different than saving for emergencies.  You may want to set aside money each month to make a large purchase at some point in the future.  Cars, appliances, and household remodeling all are great candidates for this type of sinking fund utilization.  You don't really want to use loans or credit cards to pay for those things, so using a sinking fund to put aside money every month is a great strategy.  The same principle applies: estimate how much these large ticket items will cost, how long you plan to save for them before you make the purchase, and then calculate the monthly savings needed.  In the example above, I used new automobile tires, with the idea that I only have to purchase these tires once every six years. 

Wrapping It All Up:

Making a monthly budget for predictable amounts allows you easily plan where your income is going.  But what about those larger expenses that occur infrequently?  It is much easier to set aside a predictable amount each month, and then use that money that you have set aside to pay those larger bills.  It takes away the stress caused by wondering how to pay a large expense.  By having the money already set aside, the expense is reality dealt with, and the expense is easily fit into the monthly budget.  Having a separate account for your sinking fund also has the added benefit of a disciplined routine for saving money.

If you need assistance with setting up a sinking fund, please contact me.  I have some templates that I can give you for setting up both your monthly budget and your sinking fund, as well as some other strategies for getting out of debt and building savings for retirement.

Since "retiring" from my old 9-5 job, my new endeavor is building a coaching practice that allows me to help main-street families earn more income, become properly protected, debt-free, and financially independent.  Ask me how I can help!