What is a Sinking Fund?

When this post is released, I will be sleeping in my comfortable Disney World hotel room. Becky and I have planned and saved for this trip for two years. How did we do it? We used the sinking fund approach.

Disney World

What is a sinking fund? A sinking fund is a reserve of money set aside for some purpose. This purpose may be for paying off debt, covering non-monthly expenses, or saving for a large purchase such as a vacation to Disney World.

By using a sinking fund, my wife and I did not have to borrow a single dime for our vacation. We saved up the cash, and this vacation will not follow us home with credit card bills. In addition, we are setting great examples for our children on this trip; pay with cash and don’t borrow money.

Setting Up Sinking Funds

  • Determine the purpose of the savings goal and time frame in months.
  • Make the savings goal a category in your budget.
  • Determine the required monthly budgeted amount by dividing the total dollar amount needed by the number of months for when you will need the money (savings goal)
  • Using a disciplined approach, place the monthly amount into an envelope, savings account, or money market mutual fund.
  • Utilize sinking funds for expenses that may not occur monthly such as real estate taxes, auto insurance, home repairs, auto repairs, an automobile purchase, and clothing. Oh yeah, DON’T FORGET CHRISTMAS!

Using a sinking fund is a great way to save up for purchases without going into debt. More importantly, using this approach can help you with discipline which will only improve your budgeting skills over time.

Just imagine if you used a sinking fund for auto repairs and you had to get brakes fixed. Let’s say the cost is $600 and you have budgeted $100 per month for six months. You could simply just write the check to fix the car and AVOID going into debt. Wouldn’t that be a great feeling?

The concept of using sinking funds is simple; save for purchases with cash making regular monthly deposits. If you don’t have cash, then you can’t afford the purchase. It doesn’t get any simpler than that.

Question: How do you pay for non-monthly expenses or large purchases? Cash or credit?

photo credit: tegioz via photopin cc

This post was originally published on 2/11/2013.