If you have been following us over the past year, you will know that we are on a mission to become debt free. Today I am talking all about sinking funds, and why you need them in your life. They have been the number one reason that we have stopped relying on credit cards.
What are sinking funds, and why do you need them? The term sinking funds was coined by Dave Ramsey, a guru in living debt free. They are a savings account with a very specific purpose and plan, some examples of sinking funds may include:
- Annual Homeowners Insurance
- Annual Car Insurance (if paying in lump sums)
- Vacation savings
- Vehicle replacement or repairs
- Back-to-school shopping
- Professional licensing fees
I have made a lot of mistakes when we were getting started with sinking funds, and I would like to pass along some of the things that we have learned along the way that helped us start managing our savings more effectively.
What are the benefits of having sinking funds?
The number one benefit we have experienced is that they have taken the panic out of large impending expenses.
Not everyone stresses about $1000 expenses, but for us, $1000 is a big deal. So, when our homeowners insurance is coming up, I don’t want to be caught with nothing in the account to pay for it.
This year was the first year that I was just able to walk in and pay like it was no big deal. There was no panic, no temptation to add to our debt by pulling out our credit cards and none of that heart gripping dread. Unlike previous years, I didn’t even sweat it, I simply pulled out my debit card, paid and left.
Do you want to know how great that feels?!
I felt so proud us and free walking out of that place, I could have skipped the whole way to the car!
Some pitfalls for those paying off debt
The idea of having sinking funds is amazing, but if you are “gazelle intense” about debt repayment, it can be very tempting to lump those funds onto debt. This is especially true, when you start seeing the total amount of them creeping up over $1000.
We learned the hard way, that deciding how you will manage these savings can greatly impact how successfully they can work for you. So, I think its important to spend a bit of time talking about different methods/places to keep these types of savings.
Where do you keep sinking funds?
- This works well for small sinking funds.
- It is very easy to keep funds separated by using cash envelopes. If using this technique make sure that envelopes are clearly marked with the fund name.
- It is easily accessible if you need it fairly quickly, as these are typically kept at your home.
- You have to take out cash from the bank to fill envelopes.
- It is easy to lose track of what money belongs where if you are storing all your cash together .
- Some people may be uncomfortable having larger sums of cash stashed away in your home.
- You may forget where you put it. You know when you place things in “a special hiding spot,” so special you can’t remember where it is?!… yeah, me neither…
- Cash does not not accumulate interest.
- It makes using your funds for online purchases harder, as you will need to deposit that money prior to using it.
Simple Solutions for this method:
- Purchase a small accordion folder to divide up funds. It makes it simple to label different categories, and is harder to lose than envelopes. These are often inexpensive and can be found at most dollar stores.
- Make sure the adults in your home know where your folder is kept, so they can access the funds. If your kids are anything like mine, they see cash and like to add it to their own piggy banks, so its helpful if they don’t know where to find it.
- Keep an eye on how these funds are adding up, and decide if the total dollar amount is becoming too substantial, if so, consider moving a fund or two into an online bank account.
- Money is easily usable.
- It is simple to access.
- Money can be easily used to pre-pay larger purchases if using a credit card online (this is what we do.)
- Money can be moved around easily via banking apps.
- It is too easy to access, so that it may be tempting to use when running short on money to pay for everyday purchases.
- Low rate percentage on savings accounts.
- Banking fees if using a typical brick and mortar bank.
- If you do not have the option of of separate savings accounts, it is easy to confuse where the funds are meant to be going. Many accounts will not allow you to “nickname” your account, so you will need to find alternative ways to keep your funds organized. As funds build in a single account, it is easy to become tempted to use it for non-designated purchases.
SIMPLE SOLUTIONS FOR THIS METHOD:
- Open up an account with an online bank such as Tangerine or Capital One 360 if you live in the US. They often have very low to zero fees accounts higher saving rates when compared to brick and mortar banks.
- Open multiple accounts for savings, by keep each fund physically separated, it makes it less tempting to move money around to make a purchase that the fund was not intended for.
- Nickname your accounts, so it is simple to see what each fund is for, and to easily see each fund’s balance at a quick glance. See an example of this below:
A low risk investment of some kind:
This may be especially tempting for large funds such as savings for a down payment on a home, or a 3-6 month emergency fund. However, just a reminder that savings and investments are serve different purposes, and should not be treated the same.
This is an area that I am admittedly not as familiar with (we just aren’t there yet personally), so I will share some pros and cons that I have learned from speaking to our financial adviser and listening to a whole lot of Dave Ramsey podcasts and other financial educators.
- There is potential to make a higher returns on your money, than in a typical savings account.
- It is allows your money to be working for you while you are working to add to them.
- Investments can be risky, because there is always the potential for you to lose money in this way – especially if the investment is for a very short period of time. If this is your emergency fund, obviously you don’t want to risk having less than what you need.
- There is typically a time delay in accessing these funds should you need them quickly.
If you are not comfortable with investing your larger savings, the highest rate of return I have found was for EQ Bank Online at 2.3% (for Canadians).
How we settled into a system that worked:
We initially managed our funds in a single savings account along side our emergency fund. This didn’t work at all because it was tied to our primary debit card. Anytime I couldn’t make a payment with our debit card, I would simply log into my app and transfer money from our savings into the checking and make the purchase. This led to us never maintaining our emergency fund OR our sinking funds for long.
We then started using cash envelopes more often, but because I was keeping the money in my wallet, it much too easy to lose track of what went where. Before we knew it, the money would have just vanished into thin air… or in a Tim Hortons drive through on a stressful day.
When it became very obvious that we needed to create a more effective system of keeping our paws off of our funds, we landed on what we are doing currently, and it is a blend of a little of everything.
How we manage sinking funds now:
Learn how to pay yourself FIRST!
First, we have created habits for pay day, so that I always ensure I am not undercutting our funds for our immediate needs, nor do I allow money to sit in an account un-designated for any amount of time.
On pay day these are my priorities in order:
- Tithe and charitable giving.
- To pull out enough cash for groceries and gas. (You can read about why this is always a bigger priority than bills here).
- Withdraw any money predesignated for savings (note: this is BEFORE I put money onto debt or pay our bills. If you do not pay yourself first, you will not get paid. Remember, we have worked our budget to function on a single income, that means any extra money I bring in is “bonus” and goes to cover sinking funds and savings needs – and should not be required to pay regular bills).
- Some examples of this may include:
- Any income that I bring in
- My husbands Cell phone allowance through work
- Any side hustle money I make with online sales or small side jobs
- Some examples of this may include:
- Pay bills that are due before next pay period. This includes leaving enough in the account for automatic withdrawals, but not much more.
- Pay whatever dollar amount is remaining onto debt as a debt snowball amount. Sometimes this has been as little as $25, but it adds up.
Second, I only keep enough cash in my wallet for a single week’s worth of groceries at a time. This way if I lose my wallet, or I am tempted to just grab a coffee on the go, the money is not there to do it.
If I am pulling out additional cash for one of our smaller sinking funds (i.e kids clothes or gifts) I put it immediately into its designated place so it is not burning a hole in my pocket begging to be spent.
Next, I e-transfer our larger sinking fund amounts onto our tangerine card, and divide it up into its appropriate places. Remember how tempting it is to just spend it if its easily accessible in a checking account? This applies to the online bank as well. Move that money out of checking so it is a very conscious effort to touch it if you need it.
Its okay to stumble.
I will tell you honestly that financial changes are hard, and its normal to take a few steps back at the beginning while you are trying to get your footing. In the beginning we were not as good at anticipating upcoming expenses, and ended up adding to our debt, because we just didn’t know how to avoid it.
Being successful on this path we are on, has meant learning how to be better anticipate our future expenses/needs. You should expect a learning curve with a few hiccups, as with learning any new skill. You may need to fail a few times before you find just the right combination for your family.
How many funds to I need?
How many sinking funds you have will honestly depend completely on you and your family’s needs. For us personally, we are limiting the number of accounts to just the annual essentials until we are debt free. Once we are debt free, it will allow us to contribute to our savings with each pay check, and so we will increase the number of funds we have at that time.
New sinking funds will allow us to save more heavily for things like travel, a second vehicle, and retirement.
What are some more types of things could I create a sinking fund for?
- A new vehicle
- saving for the purchase of a house
- the birth of a new child
- back-to-school expenses
- creating a larger emergency fund
- large events such as weddings or milestone birthday parties
- medical needs
- cell phone replacement
- computer or electronic replacements/upgrades (as I sit here typing on a second hand computer that may give out at any minute…)
What online bank should I use?
As I mentioned above, we personally have chosen to use Tangerine, as there are no banking fees, it provides a debit card (unlike some other options like EQ virtual), it has referral benefits, as well as a minimum of a $50 sign up bonus with your first deposit with additional benefits depending on the accounts opened.
If Tangerine doesn’t quite fit what your needs happen to be, here are two comparison charts to help you find one that might work:
- Click here for the Canadian Chart
- Click here for the American Chart
**If you are interested in opening up a Tangerine account use our orange key for your referral bonus (52519495S1).**
Do you use sinking funds? If not, what’s stopping you from getting started? Let me know in the comments below.