Do you hate Christmas shopping? About ten years ago, that was my wife and I. It took enormous amounts of time and energy. But more than that, it played havoc on our monthly budget. In December, we’d have to come up with money for Christmas gifts out of nowhere while still paying all our other bills. It was a real challenge that often led to frustration and even overspending on gifts. Thankfully, the frustration vanished the day we heard about a simple money management technique called a sinking fund.
Creating a sinking fund isn’t a new concept. However, it took me to my mid-30s to hear about it. In essence, a sinking fund is a savings fund you create for the express purpose of purchasing something in the future. As we discovered, it’s a really easy technique anyone can learn.
And it’s also one of the best practices to help you eliminate overspending and pay for bills, gifts or other budget items that come infrequently. Because certain items come infrequently, you need to plan in advance for them. That is why this article is so important to read now. Follow what I suggest now and you will be prepared for next Christmas.
This technique has revolutionized how my wife and I pay for things. You need to know how it works. At the end of the post, I’ll include the template we use to keep track of our savings.
The Sinking Fund Theory for Purchases
In the business world, the term “sinking fund” describes the practice of periodically setting aside money for a future expense. You save the money and designate it for a particular item. In that way, a sinking fund acts as a lifebuoy. It saves you from drowning financially from a big expense.
For example, a private school might know its future enrollment will grow. They know the growth will require bigger facilities, classroom furniture, and maybe even the acquisition of more land. These are all physical items needed to accommodate the growth.
So, as part of their annual budget, the school allocates a percentage of their income to a category called “School Expansion.” They don’t touch the money for teacher salaries, utilities or textbooks. It sits in savings and grows each year until it is needed.
Businesses do this all the time. The great thing is that we learned we could do this with our personal budget. All it takes is a little organization, discipline and three simple steps.
First, you need to designate what you want or need to save for.
Second, you need to figure out or estimate how much that thing will cost.
And finally, you need have the discipline to save a little bit each month towards that item.
Here is how that practically works out for us, along with the steps and the tool I use to accomplish it.
Things to Include in a Sinking Fund
As part of making our monthly budget, we had to figure out the expense categories we needed to save for. How did we do that? Simply by looking into the future and anticipating what expenses might be coming.
Related Content: The Ultimate Guide on how to Make the Best Monthly Budget
For starters, we have bills that don’t come every month. Things like car insurance, life insurance, trash pickup, pest control services and various subscription and membership fees. Items like these are prime candidates for a sinking fund.
In time, we found we could also use our sinking fund for saving for summer vacations, preparing for all our back to school expenses and yes, saving for Christmas presents.
And, maybe the mother of all sinking fund ideas, was when we realized we could save for an extended period of time and purchase a new vehicle. Granted, this was a long-term project. It took us around five years of saving month in and month out. But when the time came, we had the funds to purchase a vehicle with cash.
So the takeaway here is that you can use a sinking fund for anything you choose.
Figuring Out How Much to Save
This step requires a little bit of time and research. In order for the sinking fund to work properly, you need to figure out how much you need to save each month to pay for the expense.
Bills are pretty easy. You only need to dig up the most recent bill to see how much you paid last time. Take that bill and divide by the number of months left until the next bill comes. So, if your car insurance bill that comes every six months is $600, then you will need to save $100 per month.
The great thing about this is that the next time that particular bill comes, you won’t have to scramble to find the money in that month’s budget. You will already have it saved. The beauty of this is that you can do this for any bill that comes infrequently.
Things like saving for vacations or a new car are a little more difficult to figure out. Because those expenses will occur 12 months out or longer, they take a bit more planning and understanding of how much to save. Don’t let that deter you though. It can be done.
And I can guarantee you this – you’ll love not going into debt for the big ticket items. But the last step to this process might be the hardest.
How to Follow-Through and Create Discipline
This last step is where the rubber meets the road. You have to put your preparation into action. What you planned to do you actually have to do.
The challenge with saving a little bit each month in your budget for a future expense is that you always have the temptation to use that future money for things in the present. Instead of saving that $100 a month for car insurance, you use that $100 for whatever else attracts your attention that month. Then when the car insurance bill comes, you don’t have the total amount you need to pay it.
This has to become a habit, one that you almost don’t see happen. And the best way I found out to do this is making the process automated through your bank.
I created an Excel spreadsheet to help me get organized. (Hint: You don’t need Excel – just find the system, program or app that works best for you.) In my spreadsheet, I categorized everything we were saving for and how much we needed to save each month. I took the per month amounts for each category and came up with a total amount to be saved.
Then with that total amount number in my head, I set up an automatic draft at our bank. Once a month, I transfer the total amount of all saving categories from our checking account to our savings account. I then record on my spreadsheet that the amount for each category has been saved for that month. That’s called giving that specific amount of money a name or designation.
Then when the bill comes, I just transfer the money from that savings category back to checking and pay for it.
I found that doing this automatically through your bank helps create the discipline. In a way, the money transfer that occurs from checking to savings acts as its only monthly budget item. It happens like clockwork. The only time I have to worry about it is if I have to make an adjustment to the total amount because a specific category amount has changed.
An Awesome Way to Save for Anything
I cannot begin to describe how valuable this has been for us. It has really helped us plan for future expenses. We don’t go into debt for purchases anymore.
But we think the biggest benefits are emotional. It helps relax us when shopping or paying bills. It makes spending more enjoyable and is a reward for being disciplined.
So you can avoid that sick feeling in your stomach next December when it comes to finding the money to pay for Christmas presents. In January, start saving a little bit each month – maybe $50 a month. Wouldn’t it be great to go into December with $600 already saved for gifts?
You can download a template of my spreadsheet by clicking here. You can use it to fill in your own savings categories. There is also a .pdf here to give you a better visual of how to set it up. Check it out and see if it works for you. And please feel free to email me if you have any questions.
Answer a Question or Leave a Comment Below: Do you ever have trouble paying bills because you forgot the expenditure was coming? Do you save monthly for future bills or purchases? How did you pay for your Christmas presents this past year – cash, debit card, credit cards, other?
Image courtesy of Oleg Sergeichik on Unsplash
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