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Christmas is a perfect example.
We know it’s coming. We know when it comes. And yet it sometimes takes a panicked look across the Thanksgiving dinner table to realize that we should have started saving earlier in the year for it. We reach for the credit card, which is sitting in the wallet or purse with a wicked grin and a sky-high interest rate, saying, “I knew you’d come crawlin’ back!”
Why run your household spending plan like that? Why risk busting your budget every November when you can put time on your side by creating a sinking fund? It’s not complicated, and you can start right away.
With a sinking fund, you save a small amount each month for a certain amount of time before you make your purchase. You determine how much you save by taking the total amount to be spent and dividing it by the number of months you have left until you must pay.
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For example, if you want to spend $1,000 on Christmas and it’s April, that leaves you about eight months to save. Just put a line item into your budget that you want to stash away $125 per month until December.
You can do this with any major purchase or bill. If the cost for car insurance is $500 every six months, then save $83 a month as soon as you pay for the latest insurance coverage. If we get into February and you want to spend $50 or $75 on someone who is going to graduate from high school or college in the spring, then set 15 or 20 bucks aside each month until the big day.
Sinking Fund vs. Savings Account: What’s the Difference?
The answer is, not much. A sinking fund is usually more specific than a savings account since you know how much you are going to put in there and when you will use it. A savings account could just be a place where you put money until you need it.
If you prefer to keep your sinking-fund money in a simple savings account, that’s fine. If you do this, make sure the account doesn’t have a minimum balance to maintain (such as a money market). You don’t want your money eaten away by fees.
Sinking Fund vs. Emergency Fund
A sinking fund is also different from an emergency fund because an emergency fund is money set aside for the unknown. With an emergency fund, you might save $10,000 for a Murphy visit, and a year later get into a car wreck. You had no way of knowing the accident was coming or when it would happen, but you have the money set aside for this “life event.”
With a sinking fund, you know what the money is for and you know (about) when you are going to use it. If you want to buy a $6,000 car and are saving $500 a month into a sinking fund, you know that you’ll use the money in one year, and you know what you’ll use it on. The sinking fund is for the known; the emergency fund is for the unknown.
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Where Do You Keep a Sinking Fund?
You want to have a sinking fund in a place where you can easily get to it. The bigger the amount, the more secure you want it. If you are saving $25 a month for four months so you can buy a birthday gift for someone, it’s probably all right to keep an envelope hidden somewhere in your home (though you must make sure you don’t cheat by spending the money on late-night pizzas).
But if you are saving for a car and have hundreds or even thousands of dollars lying around, a simple savings account at the bank is probably a better idea. You can get to it easily, and you don’t risk having a pile of cash lying around if someone breaks into the house.
Sound easy? It is. So why don’t more people do it? Because it involves something that many of them haven’t mastered: patience. We live in a culture where we buy now. We bring an item home today. It’s not enough to wait for standard shipping, so we opt for express. That usually costs extra.
If, instead, you have patience and a plan, then a lot of the cost and worry associated with big purchases goes away. Credit cards and banks are counting on you not planning ahead of time so they can catch your slack and ding you with interest charges and fees. Saving up ahead of time prevents those charges as well as the stress that comes with big buys, so put that line item in your budget and ditch the worry.