Let's talk about sinking funds!
This is a financial tool I used the entire way through my Debt free journey, and something I will continue to use well into the future.
For some reason this strategy completely resonated with me as it sort of “smoothed out” those annual payments that always felt like they were sneaking up on me. This is very different to an Oh Sh!t fund. It’s not for the big expenses (like the car breaking down) but rather for those expenses you know are coming up (like a car warrant).
There are many key benefits for using sinking funds but I want to talk about why specifically it worked for me, especially at the start of my financial journey.
Before I started my debt free journey, I was living paycheck to paycheck – well actually not really because I had no pay coming in from the business, I was just living on debt. But I felt like I was on a hamster wheel. Every time I would get level with my bills some pesky annual bill would come along and make me go backwards, like a warrant or a rego payment. For a looooong time I was always angry at these payments – like it was THEIR fault I was going into debt.
Then I started to get clued up about my money and found absolute joy in sinking funds. Basically, you work out the annual cost of something and divide it over your pays in a year (weekly, fortnightly, monthly). Whatever that amount is, you put aside each pay in anticipation for the upcoming expense.
Ok so now that I have spoken complete gibberish and made you all confused, lets simplify what I have just wrote. I currently have 5 x sinking fund accounts that I use but for this exercise I am going to use the figures from my car sinking fund. Now please remember these are my figures and yours could look completely different.
Annual car expenses:
AA Membership $108.25
Just a quick note:
My insurance usually costs less than this but because I pay annually (to get the biggest discount) I don’t always know what it is going to be for the next year. I take last year’s amount, add an extra 10% then round it up to the nearest $10. It usually ends up being too much but I am ok with that. I just transfer the extra from that account onto debt or savings. I would rather be saving too much then have not enough money by the time the bill came in.
I get paid fortnightly so all of my sinking fund amounts are worked out on a per fortnight bases. There are 26 fortnights in a year so I work it out below:
Sinking fund amount:
Annual total: $1612.41
Divided by pays: 26
Per fortnight: $62.02
Each of my sinking funds have their own bank account (named appropriately and everything). I transfer the “per fortnight” amount into the account and just leave it alone. The balance does grow over time and it is very hard to ignore it but it’s helpful to just let it sit. That means, when it comes time to get your warrant you literally transfer the amount ($45) out of the car sinking fund. You can now pay for all of these expenses without worrying about where it is coming from.
Some banks even allow you to set up auto payments so you don’t have to manually transfer funds to all of your sinking fund accounts.
The best part about sinking funds? You can literally use them for any category that suits your budget!