How to Use "Sinking Funds" to Save for Goals All Year
Happy Financial Literacy Month! You know I’m trying to teach you about money all year long, but this month, money nerds like me go even harder on the advice. For my part, I will be writing about specific, concrete financial questions I’ve gotten from clients or followers in the past. This week, I’m writing about “sinking funds”. To be honest, I’d never heard of that term until Money Circle this past January when an attendee asked about it. But even though I’ve never heard the term, I’m very familiar with the idea and I actually write and talk about it all the time.
A sinking fund is a savings account that is built up over time by setting smaller amounts of money aside to build up to the larger amount. I talk about this approach all the time when talking about saving money or even paying for annual expenses. It’s a pretty simple strategy, but it does take some planning and fine-tuning.
A sinking fund is a savings account that is built up over time by setting smaller amounts of money aside to build up to the larger amount.
Identify the Goal
What do you want to save up for? Is it a trip? A wedding? Gifts for holiday season? Your car insurance payment? Anything that you know you can’t cover in a given month, or that will blow up your budget when it’s due, is worth planning and saving for. But it’s important to get clear on what those things are for you. It can be something fun or it can be something important. Either way, you’ll feel better knowing you have a plan to get there.
Do the Math
How much money do you have to save up to reach your goal? Do the necessary research to come up with a number. Look through your banking statements to see how much you paid for something last year. Once you come up with a clear number to work towards, you’ll be able to take the right steps to get you there.
Once you have the full number for your goal (or multiple goals) break that number down by month. How much do you have to set aside each month to reach your goal by your deadline? The size of the number will vary depending on the size of the goal and how soon you want to reach it. However, breaking the big number down into small, attainable chunks will make it a lot less scary and much more likely that you’ll reach it!
It helps me to create separate savings accounts for separate goals. I have one savings account for non-monthly expenses like car insurance, annual fees, etc. I have other savings accounts for things like gifts and travel. Having them separate helps me to track my progress while not overdrawing from one goal to pay for another. Usually, online banks like Ally won’t charge you any extra fees for having multiple savings accounts.
Automate Your Savings
The best way to reach your financial goals is to automate the process so that you don’t have to think about it. It takes the human aspect out of it and prevents temptation to spend the money. The best way to do this if you have a regular paycheck is to set up direct deposit. Most employers are able to deposit different amounts into different accounts for every paycheck. Ask your HR department how you can set this up and do it right away. If you don’t have a regular paycheck, or if your employer doesn’t do direct deposit, there are other ways you can do this. Some banks will automate the transfer for you. If that isn’t an option, apps like Digit will move money into different accounts for you.
Only Use It For That Goal
If automating saving is the most important thing to do, not touching your savings until you absolutely need it is the second most important thing. Don’t spend money that you’re saving for one thing on something else! This is especially true when it comes to emergency savings, which is why it’s helpful to separate that account from your checking account. However, that advice still applies to other goals you’re saving for. This is also why separating your goals into different savings accounts is useful. You can even give your savings accounts different names if you’re using an online bank. Use a clear, obvious nickname for each account and do not pull from your accounts until it’s time to use the money for your goals!
Start Over Again
Once you’ve reached your goal and paid for that thing, the story isn’t over! Presumably, an annual fee will come up again, Christmas will come again next year, and you’ll want to travel again someday. That’s why it’s important to revisit your individual goals and continue (or adjust) your savings schedule. Consider these monthly amounts a permanent line item in your budget, and you’ll always have the money when a bill comes due or a trip arises.
What are the goals or bills that you’re saving up for? Share in the comments!