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Non-monthly expenses don’t happen every day – but when they do, they can drain your bank account or force you into debt. Irregular expenses – expenses that are outside your regular monthly budget – will surface. You can’t avoid them, but if you adopt simple saving tips then you can avoid being financially ruined because of them.
We turned to co-founder and lead financial planner Thomas Kopelman Allstreet Wealth To learn more about how to use an underappreciated savings tool called a sinking fund to handle irregular expenses.
What is sinking fund and how can it help you?
A sinking fund It may have an ominous name, but its actual purpose is far from terrible: It’s a savings account (or multiple accounts) where you set aside money for planned, non-monthly expenses so those bills don’t ruin your budget.
Describing the sinking fund to his own customers, Northwestern Mutual A brief explanation of how to use it was offered: “The goal is to set aside enough money to cover this known expense so that you don’t blow a hole in your budget when the bill finally comes.”
So what can sinking funds cover? According to Kopelman, “This could include annual travel, insurance premiums, property taxes, car maintenance, or your April tax payment.”
It’s easy to confuse a sinking fund with an emergency fund because they both handle expenses outside of your normal monthly routine. The difference is that one is for unplanned emergencies (think job loss or sudden medical bills) and the other is for planned, but non-monthly expenses.
Why don’t people know about sinking funds?
Using sinking funds is such a common solution to these intermittent expenses that, surprisingly, the term is not more widely used. Personal finance education often emphasizes short-term cash (emergency funds) and long-term investments, thereby not covering the “in between” range of planned but occasional expenses. That difference is exactly where sinking funds are concerned.
“Many people don’t make progress financially because every time they’re faced with a lump sum expense, they’re not prepared for it,” Kopelman said. “This could lead to little savings or increased debt – and neither is good.”
Think about it this way: When you’re budgeting for your monthly bills, do you make room for things like annual car registration, holiday gifts, insurance premiums, home repairs or renovations, or seasonal travel? Probably not, because they feel less urgency than everyday needs – until they are met.
Setting up your sinking fund
Although you may already be depositing money into an emergency fund every month – and hopefully keep that money in a high-yield savings account – there are some practical differences in how to deal with a sinking fund. Most people benefit from having multiple sinking funds, each of which is earmarked for a specific planned expense, whereas an emergency fund is like a giant pot that you can dip into when an unexpected crisis arises.
“The best way to plan and prepare is to set up separate high-yield savings accounts for each irregular expense, then put the money into it monthly,” Kopelman said. “If you know your property tax bill is $5,000, save $417 per month to stay on track when it’s due.”
In addition to sinking funds for irregular expenses that you can anticipate, Kopelman also wants you to maintain an emergency fund for truly unexpected events — the types of costs sinking funds are not intended for.
If you feel like you’re living paycheck to paycheck, start small: Pick your highest priority irregular expense (for many people, that’s auto maintenance or holiday gifts), estimate the annual cost, divide by 12, and start automating a modest monthly transfer. Even $25 to $50 per month set aside consistently will add up and reduce the need to use credit as expenses increase.
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The bottom line is that one thing is regular in life – irregular spending. Some repairs will have to be done. Medical emergencies will occur. Someone on your holiday shopping list will have expensive tastes.
However, now that you have explained about sinking funds, you can budget wisely for these financial shocks and avoid incurring unexpected costs.
Caitlin Moorehead contributed reporting to this article.