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Sinking Funds

Normally, the start of the new year is reserved for substantive changes to my financial plan. 2020 is no different. However, as I prepare for 2021, I recently came across a concept that I’ve never fully appreciated until now. That concept is about Sinking Funds. The use of sinking funds will help me with budgeting and preparing for future expenditure. So, without further adieu, let’s dive in.

What Are Sinking Funds?

In a nutshell, a sinking fund is a fund that is used for a particular future expenditure. So, that category could be anything.

Let’s take Christmas for example. We know that Christmas occurs every year on December the 25th. However, some people still overspend during the festive holiday. Why? Because they fail to plan. But what if we approach our finances differently? What if we set our Christmas budget at the beginning of the year and save small amounts of money every month towards that specific goal? If we did that, then people wouldn’t be going into debt because they overspent during Christmas when they buy their gifts for friends and family. That’s the benefit of a sinking fund.

The idea is simple. Create as many or as few sinking fund categories as you would like. Popular sinking fund ideas include a car maintenance fund, housing maintenance, vacation fund, entertaining fund, etc. This literally could be anything you want.

Where To Save Your Sinking Funds?

You have several options in terms of where to save your sinking funds. For starters, you could do it the old fashion way and store them in various envelopes where each envelope is its own sinking fund.

If you prefer something more digital, you could create separate savings account at your favorite bank. This is certainly a viable option, but not one that I would recommend. After all, if you had 7 categories or 7 sinking funds, that’s 7 different bank savings accounts. Who wants to keep track of 7 different savings accounts?

Now, if you’re that type of person, then that is absolutely fine! There’s no one right way to do personal finance. After all, personal finance is personal.

One approach is to have one bank account, but have that account flexible enough where you can create your categories, or sinking funds, with that financial institution. That’s how Dividend Portfolio does it. Specifically, I use Qapital. Back in 2017, I wrote about how to save passively and discussed Qapital. I’ve been with them for quite a while when everything was free. Because of that, my account has been grandfathered into the free version of the account. Nowadays you have to pay to use Qapital, and it is no longer free. As a result, I no longer recommend Qapital (unless you have the free version).

So, where should you save your sinking funds? Consider such banks like Ally Bank and Sofi. With Ally Bank, for example, you’re able to create buckets within your one account. The money is separated based on your goals, and you can have whatever goals you want. When you’re ready to withdraw, you withdraw!

What About The Emergency Fund?

The sinking fund is different than your emergency fund. With sinking funds, you are saving up for planned events. With emergency funds, you are saving up for unplanned events.

We know that Christmas happens the same day of every year. The same goes for birthdays. Other expenses, even though less predictable, are still to be expected. These include housing costs, vehicle costs, vacations, etc. So, I generally don’t recommend taking money from your emergency fund to spend on vacations.

Quite frankly, to some extent, you can consider the emergency fund as a separate sinking fund.

When done right, sinking funds allow guilt free spending, and it adds discipline to the budgeting process.

Conclusion

I didn’t want this post to be very long. But, the concept of sinking funds is intriguing to me, and I hope it is to you as well. So far, I’ve established the following sinking funds in my own budget: Christmas, Vacation, Emergency Fund, House Maintenance and a separate fund for Vacancy Costs (for my rental property). I didn’t want to have too many categories, as I am just getting started. Eventually, I will add other categories, including one for Fun.

Do you use sinking funds? What did you think of this post? Let me know by commenting below.

The post Sinking Funds appeared first on Dividend Portfolio.



This post first appeared on Dividend Portfolio, please read the originial post: here

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