Here’s a real-life example of a perfect situation for a sinking fund.
It is a cold day mid-winter. Your house is -11! Bad news, your furnace has conked out. There’s only so much time to get things sorted out before the pipes burst, levelling up the situation from bad to worse. For those without a sinking fund, their minds might flood with questions like:
- How am I going to pay for this?
- Do I reach for your credit card, drain any savings and delay your financial goals, or explore options to finance?
- If I finance, does the payment even fit in your budget?
The good news is that sinking funds can change this experience. No, it still won’t be a pleasant experience, but at least the money stress layer of the equation will be subdued.
Furnaces break. Cars need repairs. Pets get sick. This kind of expense is stressful, but it is not really a surprise. However, according to a survey from the Financial Consumer Agency of Canada (FCAC), more than half of Canadians don’t regularly save to cover these kinds of expenses. Why not? For many, it’s a simple knowledge gap. They’re not using sinking funds because they’ve never heard of them. This article aims to fill in that gap, and along with that, save you money because you’ll be able to minimize taking on debt when these inevitable bumps in the road happen.
What are sinking funds?
A sinking fund is money you set aside a little at a time for a specific future expense. Think of it as a savings account with a purpose. Instead of saving in a general way, you save money intentionally. The goal is to target the costs you know are coming, even if you are not sure exactly when they will arrive or how much they will be.
That is what separates sinking funds from an emergency fund and from investment funds like RRSPs or TFSAs. Emergency funds are a safety net for unpredictable events: job loss, a medical crisis, or a sudden loss of income. Investment funds focus on long-term growth for your future. Sinking funds sit in the middle. They are short-term, goal-focused savings for the regular irregularities of life.
A budget without sinking funds is one that isn’t planning for the big picture. It only accounts for your predictable monthly expenses. It leaves the irregular ones, which are often the most expensive, completely unplanned for. That means your money plan has gaps, and those gaps are where debt creeps in.
What life looks like with and without a sinking fund
The car breakdown
Vehicles average around $1,500 per year in regular maintenance costs. That does not include higher costs like replacing a transmission. Without a fund for car repairs, you may put the bill on a credit card or a line of credit. Now you are paying interest rates on top of the repair cost.
On the flip side, with a sinking fund, you make small contributions toward car repairs every paycheque. So when the repair happens, you use the fund, and your monthly budget stays on track. Or if there isn’t enough there yet, it at least helps cushion the blow.
The vacation (The good kind of expense)
Sinking funds aren’t just for the not-so-good things that happen; they can also help you with fun things, like travel!
Without a sinking fund, travel may look like this: You decide it’s time for a vacation (which is probably much needed). You put it on a credit card, which you totally plan to pay off ASAP. At that point, you think, I may as well go big, I’m coming home to a bill no matter what. And you do come home to a big bill, with a high interest rate attached!
With a sinking fund, you have been building toward a savings goal for months. You know exactly what you have to spend. You book the trip with your budget in mind. Then you get to enjoy every moment, and come home without new debt! The vacation isn’t filled with thoughts of ‘how am I going to pay for this’ which makes it way more relaxing!
Sinking funds are not just about managing emergencies. They make the enjoyable parts of life more intentional and less stressful. Spending money that is already saved for something fun feels so empowering.
Sinking funds and your debt goals
If you are working on how to get out of debt, sinking funds are a key part of the plan. When you are paying down a credit card or a loan, adding new debt can leave you feeling defeated. Sinking funds protect your repayment plan by covering expenses that come up along the way.
Learning how to save money for specific purposes also builds better money habits overall. Pairing your sinking fund system with a no-spend challenge can give your funds a fast boost when you’re getting started.
How to build a sinking fund
Start by listing the irregular expenses you expect in the next 12 months. Set savings goals for each category. For unpredictable expenses, use your best estimate.
Divide each savings goal into regular contributions. If you want $1,200 for car maintenance over the year, plan out your transfer frequency and calculate how much to transfer each time. I like to plan for transfers to come out of my checking account on or right after payday. Automating them can make sure they happen every time.
I like to use a separate savings account for each expense, or use labelled sub-accounts at your bank. A high-interest savings account or money market account can help your funds grow a little while they sit. Remember, you want them to be safe and easily accessible. Keep an eye on Bank of Canada interest rate announcements. When the Bank of Canada rate changes, the annual interest rate on your savings accounts may change with it. A higher rate means better returns on your savings and a better APR for your savings.
Ready to build your financial foundation?
If debt is making it hard to get started with saving, you are not alone, and there is a path forward. Explore your debt relief solutions and take the first step toward a financial plan that works for your real life.
