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Sinking Funds – What, Why and How

sinking-funds-for-beginnersToday I will share to you everything you need to know about sinking funds.

 

Is this your first time hearing the term sinking funds?

 

Years ago I shared five different savings accounts you should have in order to achieve financial freedom. I mentioned emergency fund, debt-payment fund, investment fund, personal savings fund and retirement fund.

 

Sinking funds is also a term used for personal savings fund.

 

A sinking fund is typically small amount you set aside every week, every month or every year into a specific goal that’s personal to you. People build a sinking fund to purchase furniture, luxury items, gifts, upgrades and such. This is also the same fund you build for dream vacations like a trip to El Nido, Palawan or your first travel abroad.

 

You can create a sinking fund to any short-term goal you may have. And it’s actually easy to apply on your current lifestyle as well. This post will show you exactly the what, the why and the how of a sinking fund.

 

Let’s begin.

 

 




 

Sinking Fund vs. Emergency Fund

 

Do not confuse sinking fund with an emergency fund.

 

A sinking fund differs much to emergency fund for the following reasons:

 

Sinking Fund has a defined goal. You know exactly what you are saving for, how much you need and when you’ll need it.

 

Emergency Fund, on the other hand, is set on the unknown. You can’t really take a guess when an emergency happens. You can’t say you will lose your job in August or there will be a medical emergency in September.

 

Sinking Funds requires a lesser priority when you budget while Emergency Fund are most often than not the top most of the concern. Sinking Fund is for your wants whereas Emergency Fund answers to your needs.

 

Also, a sinking fund is usually carried over from month to month until you have enough money to purchase whatever it is you want to purchase.

 

Why Have a Sinking Fund?

 

One of the advantages of having a sinking fund is that it allows you to prepare for weeks and even months ahead of time for expenses so that your budget won’t get ruined.

 

For example, you want to give gifts to your family, friends and officemates during this Christmas. Without a sinking fund, you will be buying items using your usual salary or your bonus. But when you have a sinking fund ready, the amount you need to treat your loved ones can be built little by little months away from when you actually need it.

 

So if I want to budget Php 5,000 for gifts this Christmas, my sinking fund starting June will be Php 850/month or setting aside Php 425 every paycheck.

 

With a sinking fund, you will still be able to use your bonus for other expenses that matter. You can use it as initial investment and open a mutual fund account. The possibilities are endless because you are able to prepare for it months in advance.

 

If you have multiple things you want to save for like a new gadget, a new makeup, a surprise treat to your Mom’s birthday and so on, the concept of sinking fund can be really helpful. These expenses are not monthly or recurring, it is easy to forget about them.

 

Having a sinking fund allows you to track your progress easily. Instead of not saving up for anything because you either overspend or forgot about it, sinking fund helps you have the money to support your short-term wants.

 

Read Next: How To Achieve Your Travel Goals in 3 Easy Steps

 

 

 

 




 

 

How To Set Up a Sinking Fund for Beginners

 

Now that I’ve pretty much covered the basics, I will dive into the nitty-gritty part of having a sinking fund for beginners – the how. So how do you set up a sinking fund?

 

Step 1. Think about what you want to save up for

This is the first and the most important step when it comes to sinking fund – knowing what exactly you are saving for. There are plenty of different things you can establish sinking funds for.

 

I would personally recommend making a sinking fund for any major expenses you expect to have. This includes occasions such as birthdays or seasonal gifts for Valentines Day or Christmas. If you plan to go on a Laboracay next May then you better start saving money now for it using a sinking fund.

 

Maybe you want to celebrate your birthday abroad but don’t know how you’ll be able to accomplish it then have a sinking fund for it!

 

Again, your sinking fund can be as simple as buying your first MAC Lipstick to paying your annual insurance fee.

 

Tip. Try to be realistic when it comes to what you are saving up for. You should know how much you earn in a month and the essential expenses you have as well. Make sure you have something for your emergency fund, your debt-payment fund and your investment fund before even putting anything in your sinking fund. The first three should be first priority.

 

Step 2. Know much you need and when you'll need it

As you create your list of expenses, make sure you have an amount written too. Have an estimated budget for each of your sinking fund categories. Then you may want to write down the date when you'll need it. There's no need to be too specific with the date, a good month and year will do.

 

This step is necessary so you can plan what action steps you need to do in order to put money on your sinking fund. If you are saving up for a Php 20,000 camera by the end of 2019 it means you need to save at least Php 3,300 a month.

 

Looking at your current salary and budget breakdown you noticed that setting aside Php 3,300 a month is impossible to achieve. The best you can save is Php 1500 only a month. That's when you come up with solutions for the other Php 1800.

 

You could either cut back on unnecessary expenses, have a side hustle, opt for a second hand camera/research another cheaper substitute model or give your sinking fund an extra three months allowance before target.

 

Step 3. Include it in your budget categories

Now that you have your sinking fund sorted out the next step is to include it in your monthly budget. How do you budget your money with sinking funds?

 

Simple – by the process of prioritization and elimination.

 

As you allocate your income make sure you start with the essential expenses first. Make sure you have money for your recurring fixed expenses aka your monthly bills. Then, fill in your financial goal fund if you are into saving and investing. Lastly, put money whatever extra money left on your sinking fund! Now, not every item you have in your sinking fund can be covered in your monthly budget.

 

Not unless you are making a lot of money.

 

This is where step 2 comes in. Make sure you prioritize the sinking fund that’s most important for you. Arrange it by urgency and by date as well.

 

Whenever an item in your sinking fund is completed treat it as a done item. Stop saving money for it and start saving up for the new item.

 

I have a full post about budgeting for beginners you can follow.

 

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Where to put your sinking fund

 

Another frequently asked question is to where to put your sinking fund.

 

Now, you need to be very organized with your finances in order to succeed with sinking funds. Where to put your sinking fund depends on different factors. It could be based on how much money you need, how urgent you need it and even how important that sinking fund is for you.

 

Here are some rules of thumb:

 

  • If the amount is Php 1000 and above, open a separate savings account for it. I recommend opening in the bank where you get your paycheck so it will be easier to do fund transfers. This is also to accommodate automatic fund transfers which you can conveniently enroll.
  • If it is less than Php 1000, you can put it in cash envelopes and hide in a safe place. Every payday put the amount you allotted in cash. Stop saving money in your sinking fund once you have reached the amount needed.
  • If you want to be extra organized, I suggest having a different savings account and/or cash envelope for each of the sinking funds you are saving up for. This way you’ll an easier grasp on whether a sinking fund is done, not anymore relevant/important or have yet to be completed even started.

 

What you can save in your sinking fund?

 

There are plenty of use for your sinking fund. I try to make one for every wants I have in my life.

 

Travel. I think this is the most common use of sinking fund. If you have an upcoming travel plans, whether a simple vacation or an outing with family then save up for it in advance. Just research on the destination and find blog posts about it with budget inclusion. Then save up.

Related read: First Timers’ Guide to Seoul 4 Days 3 Nights

 

Occasional/Seasonal Gifts. You can also use sinking funds when it comes to loved one’s birthday, Valentine’s Day and/or Christmas Day gifts. Again from my example above, you can already save up on December Christmas gifts as early as July. You can set aside Php 1000 every month and have enough money by the month of December to shop.

 

New gadget/luxury item. If there’s anything you are really wanting to get but don’t want to feel guilty about, then sinking funds can be helpful. If you enjoy travelling and would want to own a good camera, then you can simply set up a sinking fund for it.

 

Home Repairs/Upgrades/Makeovers. Home repairs, furniture or appliance upgrades as well as room makeovers are never cheap. It always comes with a certain expense. This is where sinking funds come in. It may be small amounts every month, but after six months to one year it will be a good amount for a new sofa or a better roofing.

 

Other options. You can also use a sinking fund for getting a certification degree, attending a concert, tuition fee or for pets.

 

 

 




 

 

How Sinking Funds differ from a typical Savings Account

 

I’ve talked about having a dedicated savings account a couple of times here on the blog. It is the quickest way you will be able to save money and stop living paycheck to paycheck.

 

Sinking Fund is a powerful tool if you often have excess cash here and there you want to put in to good use.

 

For example, your budget reveals that you have an excess money of Php 3,000 every month. That’s Php 36,000 in a year. You can use that money all out in a vacation or start different sinking funds with the other “wants” you have in life.

 

Here’s how the alternate scenario will be:

 

Php 3000 will be divided into three sinking funds.

Php 1500 for a vacation

Php 1000 for a new gadget

Php 500 for gifts

 

After a year you have:

Php 18,000 for a vacation

Php 12,000 for a new gadget

Php 6,000 for holiday gifts

 

That's maximizing the limited money you can save in a month. And because it is gradual, you will not feel intimidated or pressured with the numbers at all. You are still able to accommodate your essential expenses plus whatever financial goals you may want to achieve.

 

Final Notes from SavingsPinay

 

Sinking Funds are real game changer when it comes to making an effective budget. It allows you to prepare for weeks and even months ahead of time for expenses so that your budget won’t get ruined.

 

Not only is it effective but also easily modified to your current budget method. Just do the three step process:

Step 1. Think about what you want to save up for

Step 2. Know much you need and when you'll need it

Step 3. Include it in your budget categories

 

Again sinking funds are different from emergency fund and a regular savings account. You are doing sinking fund for variety of expected expenses that you want to slowly (but surely) save up for.

 

Check out my post on 11 Ways You Can Start an Emergency Fund from Scratch. I hope this post helps you. If it did make sure you share it. You can also follow me on my personal Instagram account – @izzaglino.

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What do you think of sinking funds?

Clariza Glino

Izza of SavingsPinay helps Filipinos bridge the financial literacy gap one content at a time by providing insights and tips on budgeting, saving, investing, side hustle and growing your net worth. Aside from this blog she also writes at www.izzaglinofull.com, a beauty and lifestyle blog for frugal Pinays and manages, www.izzagevents.com, a wedding and event business since 2011. For inquiries, topic suggestions or future collaborations email her at izza@savingspinay.ph

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