Eliminate Sinking Feelings with Sinking Funds

We have all had that feeling. That sinking feeling. We nonchalantly walked to the mailbox (or our inbox), opened the mail, and one of the envelopes/emails was a big bill staring us in the face. Maybe it was a medical bill, a bigger than expected credit card bill, our property tax notice. Our monthly house payment just went up, or that first college tuition bill is due. Gulp! It was something that knocked the wind out of us and made us scramble to check our account balance and do the monthly algebra to figure out how to cover that big payment.

Sometimes life is that way – full of fun and not so fun surprises – and it’s certainly true we can’t always anticipate what is around the corner. But other times, with a little forethought and some crafty execution, we can avoid that moment that sets us back on our heels. That sinking feeling is no match for our hero:

Sinking Fund Basics

What in the blazes is a sinking fund, I can hear you asking. Ok, that would be me asking that. I’m not sure you use the phrase “what in the blazes” that often…or ever. Regardless, however you do ask, you are asking a great question. Thanks for asking.

A sinking fund is money that you set aside in advance with the goal of accumulating funds prior to needing them. A sinking fund is typically created with a specific use in mind. You can have a sinking fund for an upcoming vacation, a large bill that you know is coming, a home renovation, or just about anything. We can fill in some more of those blanks later, but right now let’s make sure the concept is clear.

If, for example, we have our eye on a piece of furniture that costs $800 and we want to buy it in by the end of the year, we can use a sinking fund to save up the money for it. A little math tells us that if we are in May and we are going to buy it in December, we have 8 months to save up the money to buy it. If we save $100 each month and set it aside in our sinking fund, we will have the cash to pay for it by December.

The concept is very simple, but like a lot of simple concepts, it is applying simple things in clever ways that can make them genius. Sinking funds, if used properly, can save you hundreds of dollars a year. How? Read on.

Auto Insurance Example

Applying the sinking fund concept to car insurance is a great example of using a sinking fund to save money. You know your car insurance premium will come due every six months. It’s like clockwork, if a clock could mark off six months for you. (Shouldn’t that be a calendar, not a clock? I digress.) You know exactly what months your car insurance will be due. Let’s say you get your car insurance renewal and the bill is $1,500. That’s not money you typically pay – only twice a year, right?! – so you have that sinking feeling and decide maybe you won’t pay the $1,500 that month. After all, the kindhearted insurance company will allow you to pay that bill in monthly installments. That would be $250/month. You relax because that takes the pressure off for this month.

But wait, maybe there is a better way. Let’s wind the clock (or calendar) back six months and use a sinking fund instead.

It’s November and you just paid your car insurance. Oof, that $1,400 bill hurt, but you covered it. You decide to set up a sinking fund to make it easier to pay that next insurance premium in May. You look at your bill of $1,400 and you divide it by the 6 months you have until your next bill comes due to give you $233.33 per month. You contact your bank or credit union, and you open a new savings account and you nickname it “car insurance sinking fund” in your bank’s online app. You then proceed to set up an automatic transfer of $233.33 on the 10th of every month starting in November from your checking account where you paycheck is deposited to your new car insurance sinking fund. The new account will keep the funds separate so you are not tempted to spend them, and the automated transfer means you won’t have to remember to move the money. You just put your new car insurance payment on autopilot. By the end of January, you have three months saved and $699.99 sits comfortably in your sinking fund. When May 1 rolls around and you get your new insurance premium notice you see that our kindhearted insurance provider has seen fit to raise your premium to $1,500. That’s okay because your sinking fund sits ready with just under $1,400 in it. Not quite enough to cover your bill, but at least it is most of the way there.

Hold on! You see something in the fine print you haven’t seen before. Your insurance company offers a discount if you pay the entire amount in one payment to renew the policy. The discount is 6% and you avoid a $3 installment fee for each of six monthly payments. Your 6% discount lops $90 off your bill and avoiding the $18 of installment fees means your $1,500 bill just became a $1,392 bill. Seeing that you have $1,400 in your sinking fund, you transfer the money to pay the bill in one payment reaping the discount, saving the fees, and using your sinking fund to avoid that sinking feeling of having to come up with $1,500. It’s a win all around. This is the “financial peace” you keep hearing about, but not experiencing.

At this point after you are done patting yourself on the back, you may want to project your next bill and slightly adjust your monthly transfer into your sinking fund. If your premium increased $100 this time, you might want to bump up the amount you use to fund your sinking fund by another $30/month just to give you a little cushion. The goal is to cover the whole bill, so if you have a little left after you make the next payment, it gives you a little head start on the next round of deposits into your sinking fund.

Here a Fund, there a Fund, Everywhere a Sinking Fund

Now that you have seen the magic of the sinking fund, you start to get more bright ideas of how to apply it. After all, if it works for car insurance, it can work for all sorts of things, right? Life insurance? You bet your life. Property taxes? Bet the farm on it. Vacations? Yes, you can get away with that. Home improvements, saving for a new car, Christmas presents, year-end charitable giving. If you can plan in advance for it, you can create a sinking fund to do it.

There are a few tips that make sinking funds easy to use. First, some banks have the concept of subaccounts or buckets. These buckets allow you to segment money within a single savings account. That can be handy because you can create buckets on the fly without needing to contact your bank to set up a new account. The downside is that you might be tempted to comingle your sinking fund with other money in your savings account. One reason sinking funds work is because you move the money and don’t touch it until you need to make your payment. If you might be tempted to dip into the bucket for other uses, you might be better to have a separate account for your sinking fund.

Second, use the automatic transfer like in the auto insurance example. Moving smaller amounts that accumulate over time into the amount you ultimately need is great. Automating that process so you don’t have to remember to move the money is even better. When life gets busy – is it ever not busy? – automation can save you some brain cycles and lower your stress, so I highly recommend using automated monthly transfers to fill up your sinking fund.

The way we have structured this, you are transferring money from a checking account to a savings account where your sinking fund(s) live. Savings accounts have limits on the number of transfers you can make out of the account, so make sure you stay within those limits. Unless you have a dozen or more sinking funds and half of those have payments due in any given month, you are probably fine, but it is good to be aware of the limit so you don’t run the risk of incurring fees for too many transfers out of your savings account.

Conclusion

Sinking funds work. You may not be able to do them for everything right away, so start with one use and bump up the number of sinking funds over time. Once you have a system in place, it will allow you to take advantage of discounts and it will lower the stress of seeing those big numbers on some of your bills. Using sinking funds saves me several hundred dollars a year. I avoid installment fees and I take advantage of discounts offered by making a single payment. Best of all, sinking fund means no more sinking feelings when big bills arrive.

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