Recently, I’ve been reading a lot of questions coming from people seeking out financial advice. There are two related questions that are being asked in various ways, but at the end of the day, those who reach out want to know the same two things:
What is a sinking fund?
How do I create a sinking fund?
These are two really good questions for something that has been around for quite a long time. Quite simply:
A sinking fund is a place to put a set amount of money over time in order to reach a financial goal.
I can see that a bunch of you are scratching your heads right now. Don’t panic! I didn’t know about what a sinking fund was until about 5 years ago. I’ve had some practice and the good news is that I am a master at creating them. The good news is you can create one within your written budget. So let’s look at an example:
Say you want to save up to buy something really cool. I am a big nerd so we are going to buy the a Super Cool Stand Mixer for $600 (yes this product actually exists as I was looking up one the other day). Remember: before you buy toys (unfortunately a Super Cool Stand Mixer is a want and not a need), it is important we are debt free! That way we are paying ourselves and not giving our money away in payments.
Since we have been really diligent with our Zero Balance Budget we have nothing saved up for this particular expense. So let’s add a column in our budget:
Now that we have it added to the budget, let’s figure out how long we have to wait to pay for it. In this example, we make $1,900 a month. After all expenses have been paid, we find that we have an extra $100 a month that we can put towards the mixer.
Alright now for some quick math. We want save up $600 to buy the mixer, and can put $100 a month towards the purchase. The equation to find out long we need to wait looks like this:
Target amount / $x per month = Number of months
Now for some quick math
$600/$100 per month = 6 months!
By saving this way, we would need to wait 6 months before we could buy the mixer. That’s right. We have to save up and pay for it, which means that we have to wait until we can buy it. Waiting for things, whether it be products or services seems to have become a lost art form in our culture of instant gratification.
Why wait if you can have it now?
Sound familiar? Sinking funds seem less and less attractive as things have become easily accessible. I would say that the name “sinking fund” is partly to blame. I mean, when was the last time that you hear the word “sinking” in a positive light? All I can think about is the Titanic and that didn’t end so good.
I say that it should be called the “Save and Pay” method. You save up for something, and then you pay for it! What a concept! It doesn’t sound as stuffy either. The really cool thing is that it gives you a cool down period between purchases. If you really want that Super Cool Mixer after 6 months then I would say that is a solid purchase. Thus, creating less buyers remorse! So, not only do you have no payments, but you have less guilt when buying. What a deal!
Summary: A sinking fund is money you put aside for a certain amount of time in order to pay for the item. To find out how long it will take to save for something, just follow these steps:
- Find out the total dollar amount item you wish to purchase costs.
- Figure out how much you can put towards that purchase each month using your budget.
- Divide the total cost by the amount you are putting towards it per month to find the number of months it will take.
There you have it! It’s as easy as 1-2-3! By using the Save and Pay method, you will not only skip the debt and payments, but you will know if you really want to purchase the item you are saving for. Whether it be a Super Cool Mixer or a vacation, the sky is the limit when it comes to saving and paying.