Taking the stress out of long-term expenses
Just as I graduated college, moved halfway across the country, and started my first job, a months-long string of bad luck hit me hard. My first week at work, I got hit with a thousand-dollar repair bill due to my car running into some serious engine trouble. A month later, I had a severe allergic reaction while traveling for work and had to be taken to the hospital. A few weeks after that, I spent hundreds on a night guard, which of course was not covered by insurance, to address my newfound stress-induced teeth grinding habit. Around that time, I also came to realize that my toxic work environment could no longer be justified by the paycheck. So I decided to quit without having a new job lined up.
While this series of events is a much smaller deal, and could have been handled much better in hindsight, much of the stress associated with it stemmed from having just graduated with very little time to build up much in the way of a safety net. Once I found a new job and got enough distance from those few particularly stressful months, I realized that getting smart with my money was absolutely critical for taking the stress out of the bigger expenses that always seemed to come up at the most inopportune of times. Preparing my savings account for these events would not only keep me out of credit card debt and keep my emergency fund healthy, but it would also give me the peace of mind I needed to start investing consistently.
How Emergency Funds and Sinking Funds Differ
Sinking funds are used to financially prepare for a planned expense or expected future event while emergency funds are used to cover you financially in the event of an unexpected and significant setback.
What constitutes a financial emergency will be different for everyone and will inevitably change over the course of our lives. That said, the three potential emergencies that come to mind at my age are car accidents, hospitalizations, and protracted periods of unemployment. Consequently, these are the only times when I would dip into my emergency fund. I recommend reserving emergency funds for the truly unexpected events that could significantly compromise your overall financial position without adequate preparation.
Larger expenses that I can reasonably expect in the future, such as new contacts and prescription glasses for my rapidly deteriorating vision, maintenance on my car, and most recently, another interstate move, are where my sinking funds come in. Sinking funds can be tapped for any large yet planned expense that would either significantly distort, or not be covered by, your monthly budget. Sinking funds are not only ideal for covering large, mundane expenses such as car and home repairs, but they also come in handy when saving for upcoming events, such as a trip home for the holidays, a friend’s wedding, or even purchasing a starter home.
My 5 Sinking Funds
Sinking Fund #1: Medical — $50/paycheck, or $100/month
My medical sinking fund is the largest of the five. I contribute to this one each month, without capping the total balance in the account, in order to cover my prescriptions, yearly checkups, and specialized care.
Since my emergency fund already accounts for hospitalizations and accidents, I only keep a medical sinking fund for the routine, out-of-pocket medical expenses that come up during a typical year. And while I contribute regularly to an HSA, I prefer not to touch these funds so that they can grow over time and be leveraged when I may need them more in retirement. Depending on your insurance coverage and overall health, a medical sinking fund may or may not be necessary.
Sinking Fund #2: Car — $20/paycheck, or $40/month
My car sinking fund covers yearly inspection and registration fees, as well as routine maintenance such as oil changes and tire rotations. I add to this fund monthly but cap the total amount in this sinking fund at $500. Once I hit the $500 mark, I transfer any future contributions to the car fund into either my Roth IRA or other retirement accounts.
Sinking Fund #3: Moving — $100/paycheck, or $200/month
I have an interstate move coming up in May. And moving is not only stressful, but it’s also pretty expensive. So for a few months now, I’ve been adding to sinking fund #3 — my event based fund.
Even without an upcoming move, I still add to my event-based fund at the same rate each month so that I’m prepared for anything else that may come up. In the past, I’ve used this sinking fund to cover birthdays, Christmas presents for my very large family, and any surprises come tax season.
Sinking Fund #4: Travel — $10/paycheck, or $20/month
My travel sinking fund includes airfare to see my family once a year around Christmas. While it may seem silly to put aside just $240 over the course of a year, doing so allows me to enjoy a stress-free holiday by taking another expense off my plate at a time when I, like most people, tend to spend much more than I normally would.
Sinking Fund #5: Clothing — $50/paycheck, or $100/month
I like to cap this fund at $500, and it has come in handy as I slowly build up my professional wardrobe. As with the car fund, I contribute any amounts in excess of $500 to my retirement accounts.
Tips for Creating Your Sinking Funds
Tip #1: Understand Your Budget
Before I came up with the monthly amounts that I could realistically add to each sinking fund, I looked back at 6 months of trended expenses and compiled just over a year of my larger bills. This data not only clued me into what my bigger expenses are on an annualized basis, but it also showed me how much money I could actually throw at them each month without neglecting the other components of my financial plan, such as investing consistently toward toward retirement.
Tip #2: Think About The Items That You May Need To Replace Or Will Owe Soon
Whether you own a home and your AC unit is starting to falter, or your car is nearing the end of its useful life, sinking funds a great tool to save up for these expenses over time. Sinking funds also come in handy for large yearly expenses such as taxes if you are self-employed, own a home, or tend to owe at the end of your filing process. Creating sinking funds for these less frequent, bigger ticket items, creates more consistency in your overall budget and reduces the stress inherent in forking over large sums of cash all at once.
Tip #3: Think Back To When You’ve Needed Credit In The Past
The primary advantage of sinking funds is that they prevent you from going into debt when a bigger expense comes your way. So think back to the times when you’ve been strapped for cash and were either tempted to, or did turn to credit cards, in order to finance those expenses.
The easiest way to start this step is to categorize the instances in which you saw your day to day finances stretched. Was it a costly home repair? Did you need to replace your tires at an inconvenient time? If so, those should be your sinking fund categories. In my case, eye problems and special occasions tend to apply the most pressure. So I gave them their own sinking funds.
Tip #4: Consider Your Long-Term Savings Goals
Labeling and allocating your savings towards each of your sinking funds should directly further your financial goals. While your priorities will inevitably change over time and re-evaluating your sinking funds every year is highly recommended, keeping your bigger goals top of mind is key.
While I don’t currently have a home sinking fund, dedicating and contributing to one relentlessly is an absolute must if you plan to purchase a home in the future. And because I replaced my old car last year with one that I plan to drive into the ground, I’m not saving for a new one anytime soon. My sinking funds fit my current lifestyle and will be updated when the need arises.
Before opening a stream of new bank accounts or breaking out a stack of cash envelops, take a minute to jot down what’s on your financial horizon.
Tip #5: Use A High Yield Savings Account
While the cash envelop method for keeping sinking funds tracked and separate is rather popular, it comes with four primary disadvantages. First, the envelops can get lost or stolen while sitting at home. Second, cash envelops require you to physically count your balance every time you add to them. This is a somewhat minor inconvenience but still worth mentioning.
Third, having the cash right in front of you may tempt you to spend it on unrelated items. Fourth, putting the money in a high yield savings account, such as those offered by Ally and CIT banks, allow you to earn a little interest on top of what you are already putting away for these future expenses. I like to use a separate account for each fund, but this is just a matter of personal preference.
Tip #6: Automate Your Deposits
I’d heard this personal finance advice just about everywhere for months but discounted it since I had already considered myself to be a pretty good saver. But even as someone who prides herself on maintaining a high savings rate, I started to notice how many smaller purchases I’d allowed to fall through the cracks near the end of each month.
Consequently, I decided to automate each sinking fund transfer. This small change not only guaranteed that I would remember to make each deposit, but it also made certain that I wouldn’t be tempted to spend the dedicated savings elsewhere. Keeping your earmarked savings out of your checking account to begin with is especially important when saving towards longer term goals.
Tip #7: Consider The Opportunity Cost Of Saving Too Much
The number of unique sinking funds you need and the amount required in each will differ for everyone, but I recommend keeping in mind the primary purpose of sinking funds: to keep you out of debt. Once you feel adequately covered, any additional savings can be put to better use by investing in the stock market or exploring other avenues of wealth creation.
If you’re struggling to decide how many sinking funds you need or how much to allocate toward them each month, think about your day-to-day liquidity. If you have the room in your monthly budget to cover hundreds of dollars in surprise expenses, you may need to put less into your sinking funds ongoing. Cash flowing what you can each month will allow you to build wealth a little quicker while still granting you have the level of security that you require.