Are you wanting to understand the purpose of sinking funds? – Let me explain…
We live in a world of instant gratification. The “buy now; pay later” culture and “expense by credit card” lifestyle, seems to be reigning supreme and with Christmas around the corner, what better than to shop till we drop for our loved ones and stick it on a credit card!
“After all, it is Christmas and I can worry about paying it off in the New Year, right?“
Nobody wants to start a New Year in debt, and the good news is that you don't have to if you look to start a sinking fund.
What Is A Sinking Fund?
So, what exactly is a Sinking Fund?
A Sinking Fund is a way of saving towards a future expense, without going into debt, by setting money aside on a frequent basis over a period of time with the aim of purchasing an item at the end of a set point in time.
It is effectively “Save now and buy later” with the added bonus of not incurring an interest charge.
This can be done by setting up a direct debit or standing order from our main current bank account to a savings account (or savings pot) on a periodic basis – weekly, monthly or quarterly – at your convenience.
Alternatively, it can also be done using YNAB creating categories and goals for each of your sinking funds, that can be broken down with a goal date and target balance.
Why Should I Have A Sinking Fund?
Sinking Funds can help us plan towards events like birthdays, holidays, car insurance, weddings, a car purchase, a deposit for a new house, school expenses at the start of the academic year etc.
It can be for any length of time and there is no limit to the number of Sinking Funds that you can set up.
For instance, if we love to spoil our loved ones at Christmas, a good way would be to save up at the beginning of the year for shopping over the festive period.
The amount you spent last year should give you some idea of how much you are likely to spend this year.
If you estimate that you will spend £1,200 on gifts and presents next year, then in January allocate a twelfth of this over the year (£1,200/12) by setting aside £100 a month into a saving account so that by December next year, you do not have to resort to a credit card.
Even if your gifts were slightly over budget, it will be less painful than not having saved anything at all!
The Difference Between A Sinking Fund & An Emergency Fund
A Sinking Fund is very similar to an Emergency Fund, but they are not the same thing.
The main difference is that for an Emergency Fund, money is set aside for unknown real-life emergencies; things we cannot foresee, control or plan for.
A good example would be for a boiler breakdown right in the middle of a snowstorm or your washing machine breaking down when you have a toddler and a new-born born baby and multiple cycles of washing each day – how inconvenient!
In essence, an emergency fund is money set aside for the unexpected financial interruptions of life whilst a Sinking Fund is money set aside for known and specific purchases.
Benefits Of Having A Sinking Fund
The benefits of having a Sinking Fund are both quantitative and qualitative in nature. Here are a few examples;
Live Debt Free
It is possible to live debt-free – Afterall our ancestors did!
To be able to save up for something and then buy it, means we do not incur interest and do not live weighed down by debt.
Getting paid at the end of the month, and the very next day you are broke as all your salary as been spent paying off repayments and credit cards etc. is going to cause a debt spiral.
Instead, creating sinking funds allows you to maximise your income and pay cash for the things you want or need.
There is something satisfying about saving towards something and being able to pay for it in cash.
To be able to go on a luxury holiday to an exotic location – I'm talking blue skies, sun, sand and beach – and stay in a 5-star hotel without feeling guilty.
It's all possible when you set up a Sinking Fund enabling you to save towards something you want instead of paying by credit card and then return home with “buyer’s remorse” when the credit card bill comes in!
Set an Example
At the start of the recession of 2008, a young 28-year-old couple was shown in a documentary on TV in the UK.
They had two young children and had amassed credit card debt of over £50,000 and did not own their own property.
They had spent luxury items and designer clothes for themselves and their children. The sad thing is that this will be a “normality” for their children unless they break the cycle of debt and ditch the “expense by credit card” way of life.
We need to set an example for our kids and watch the joy in their adorable faces when they buy something, they have saved up for themselves – an invaluable lesson that not even our educational system currently provides.