What is a Sinking Fund and Why You Should Have One
In the world of personal finance, you might have heard of an emergency fund, but have you heard of a sinking fund? In this blog post I’m going to explain both and hopefully by the end you’ll be heading to your bank’s website or nearest branch to open up an extra account to start your own sinking fund if you don’t have one already.
Sinking Fund:
A sinking fund is like a savings account with a specific destination in mind. It's your way of planning for known, infrequent expenses, such as annual insurance premiums, vacations, or car repairs. We know those all happen, but they can be hard to budget for on a monthly basis because they don’t happen every month. By setting aside money regularly for these expenses, you're better prepared when they come knocking. In Denver, where you might face varying seasonal costs (hello, heating bills and ski trips), having a sinking fund can keep your budget afloat. Your sinking fund should be in a bank account that doesn’t have restrictions on how many transactions you can post in a month, because you’ll be using it. In summary, a sinking fund is a savings account that you’re allowed to touch regularly.
Emergency Fund:
Maybe you’ve already heard of an emergency fund from our earlier post. It’s your safety net for unforeseen financial curveballs, like a sudden medical expense or unemployment. It's your financial life raft when the unpredictable happens. Having an emergency fund provides peace of mind for sure, but more importantly it has you prepared for the worst case scenario. So in short, an emergency fund is a savings account that you only touch in a true emergency. You can drag me for this, but Taylor Swift tickets are not an emergency and neither is your BFF’s bach in Cabo.
“So how much should I put in my sinking and emergency funds?” is a question I get a lot. There’s conventional wisdom about emergency funds, most folks say you should have 3-6 months expenses saved (that’s going to be anywhere from around $12,000 to $31,500 if your expenses fall between the ranges seen in my last blog post about the cost of living in Denver). When it comes to sinking funds, there’s a variety of opinions. Personally, I like to keep between $3,000 and $4,000 in my sinking fund. I got to these numbers because I figure if it didn’t rain but it poured, I’d have some nasty luck and need to make a big car repair right after booking a vacation. I want my sinking fund to have more than enough to cover those planned expenses, but I also want to replenish it relatively quickly. So personally I contribute $250 a paycheck to my sinking fund, or $500 a month. This number may be very different for you. Whenever my sinking fund hits $4,000 I transfer $1,000 out to my long term savings account and while that doesn’t happen as often as I’d like it to, it always feels great when I’m able to do that.
Are you sold on a sinking fund? Want help organizing your finances? Contact Prosperity to schedule a money date!
