Sinking Fund: Do You Need One and How Does it Work?

Sinking Fund: Do You Need One and How Does it Work?

Small Business, Money Management, Personal Finance, Saving Money

Ihave started using one of my accounts as a sinking fund savings vehicle. Why? Because I am terrible at money. Sometimes, not all the time. Yes, I set money aside for my pension and emergency funds. Some of my money goes into my Saccos member savings account with the hope of borrowing against it to purchase assets or withdrawing when it is absolutely necessary. The rest, I have been putting in an MMF account, Sacco’s FOSA account, and I leave some money in my current bank account.

I have realised that some of the money I put aside in my savings accounts usually goes into unexpected expenses. And they are not necessarily emergencies. I have paid for land purchases and processing parcels that are not mine because someone realised they could not foot the bill at the last minute. I keep bailing my people out of situations just because I have some funds in a savings account. Some are not even emergencies, to be honest. Part of the black tax, I guess. Other times, I see an item online and decide to get it just because.

Clearly, this saving system is no longer working in my favour. There are assets I have wanted to purchase, and now that I need them more than ever, I realise my supposed savings are nowhere. Sadly, achieving some of my goals will take me longer than expected.

Hence the decision to be stringent with this black tax issue and start a sinking fund for some of my planned expenses. It is part of bettering my financial strategies as I also try rebuilding my emergency fund. I am looking to build savings accounts for specific expenses, like purchasing household appliances, business equipment, vet visits, insurance premiums and a travel fund. While I might not have all these accounts at once, I will start with the most pressing issues. I have already started using one of my MMF accounts to save for next year’s insurance premiums.

If you are in the same situation, maybe it is time you opened a sinking fund. But what is it, and how does it work?

Table of Contents

What is a Sinking Fund and How Does it Work

In corporate, sinking funds are usually used to hold money for paying off debt, like bonds or significant future expenses. This makes the bond payoff at maturity easier for the company. In personal finances, a sinking fund is supposed to serve the same purpose; ease the financial burden of meeting a major expense. However, it doesn’t have to be a loan payoff only. You can use your sinking fund account or accounts to save money for several expenses you are planning to make at a later date.

For example, maybe you are planning to upgrade your smartphone, television, car, go on vacation, buy gifts or buy a specific asset. Whatever expense you have in mind, you can choose to save this money in an account meant for this particular purpose only. So, you will have to set aside a certain amount or percentage of your paycheck toward this goal every month. You also need to have a timeline for your expense. Remember the strategy of setting SMART goals? Knowing when you need to make the purchase allows you to keep track of your progress and measure it at every step. Are you getting any closer, or should you revise something?

Besides making it easier to pay for significant purchases, a sinking fund is also beneficial because:

It allows you to save for any expenses, even if it doesn’t involve the purchase of an expensive asset
Guilt-free spending – you don’t have to question your financial position after spending since you have been planning for it all along
You can prepare for expenses rather than wait for situations to turn into emergencies. For instance, you can start saving for home or repairs when you see signs of wear and tear.

Sinking Fund vs Emergency Fund

While you use a sinking fund for a specific and defined goal, your emergency fund is money you save for the worst, unexpected and unknown expenses. This ranges from job losses to medical expenses your insurance cannot cover. Your emergency fund should have at least 3 to 6 months of living expenses.

Sinking Fund vs General Savings Account

Your general savings account, like mine, has money you set aside simply because you want to save money. You could have a goal in mind. But I have realised it is pretty easy for the lines to be blurry during expenses. One need here and another expense there, and you are using your savings for just any purchase.

A sinking fund, on the other hand, allows you to be more intentional with your spending. Separating money for specific goals ensures it does not get tangled up with the rest of the savings.

But won’t you end with too many saving accounts if you have several goals at once? Yes, you will. But having multiple savings accounts allows you to keep your savings goals organised with better tracking and management. If you have several plans at once, you can have different sinking fund accounts for these goals. Then, when it is time to spend, consider whether you have saved enough for the goal or whether there are other goals you can forego at that moment.

How Do You Create a Sinking Fund

Setting a sinking fund is quite easy with the below steps:

First, what are you saving for?
How much do you need – once you know what you are saving for, you can estimate how much it will cost.
Timeline – it makes estimating how much you need to set aside every payday easier. Let’s assume you need Ksh 100,000 for your holiday vacation, and you have 3 months to save. You will have to save about Ksh. 33,333 every month to afford your vacation.
Budget for it – adding this money to your budget ensures you do not divert the funds into other expenses.
Where will you save the money? Whatever account you choose needs to be liquid and doesn’t take much of your money for maintenance fees and such costs. It also needs to be separate from other accounts, especially if you do not trust yourself not to use the money for other expenses.