Last updated in July 2020
Learn how to set up a sinking fund. Having a sinking fund for your anticipated expenses is part of good money management. And it is crucial for avoiding future disasters of not having enough money for holidays, weddings, etc.
Yet many people do not have a dedicated sinking fund. Even though it is easy to set up a sinking fund, it is hard to get started when you have no idea what to do. This post will show you how to build your very own sinking fund.
Table of Contents
How to set up a sinking fund for beginners
What is a sinking fund?
A sinking fund describes savings that are dedicated to a specific expense. This expense is expected, unlike an emergency fund which covers unanticipated costs. What the expense is, depends on you. Examples include:
- Annual car insurance payment
- Anticipated car repairs
- New electronics
If you have more than one big expense coming up, you can have a sinking fund for each expense or have a combined sinking fund for everything.
Why you need a sinking fund
Having a sinking fund is important to spread the cost of large expenses evenly over a number of months. This ensures that you have sufficient money when you are making the purchase. Additionally, you will not have all the financial repercussions in the month you are making the purchase. Rather than being dirt poor in that month, you can live normally throughout the year.
How much should be in your sinking fund?
How much you should have in your sinking fund depends on the expense you are saving for. Sometimes you will not know how much you actually have to pay but you can make an informed guess.
For example, if your annual car insurance payment was £500 last year, you should aim to have £500 in your sinking fund by the time of renewal. If you have not had any incidents, you will likely pay less than this but your quote could also go up or stay the same. Therefore, having £500 ready will put your mind at ease.
You have 12 months to prepare for this payment. So if you expect you will need £500, you could transfer £42 every month into your sinking fund (500/12). If you are not on a regular salary, you may want to increase your contribution in months in which you earn more and decrease it when you earn less.
How to find an account
Finding the right account for your sinking pot can be a challenge. You should keep your sinking fund separately from our main current account unless you are good at money management and keep a spreadsheet detailing what part of your current account is our sinking fund.
However, as you do not need your sinking fund immediately, it makes more sense to put it somewhere where you earn interest. Good places for your sinking fund include:
- Instant-access savings accounts
- High-interest current accounts
- Fixed-term savings accounts
- Premium bonds
Generally, the amount of money in a sinking fund is not great enough to justify the time it takes to chase the highest interest yielding account. Rather, you may prefer to choose an account that is most convenient for you.
You can check with your bank if they offer a savings account that pays more than 0.5% interest. If not, you can open a separate savings account, for example, a Marcus account. As we are in a low-interest period right now, premium bonds can be a good alternative and give you the chance to win a £1 million jackpot and other tax-free prizes.
Not that it is not recommended to keep your sinking fund in equities such as index trackers. The volatile nature of stocks means that you may not have enough money when you need it.
How to keep track of your savings
Once you have set up your sinking fund, it is crucial that you keep track of it and monitor your progress. This is to ensure that you are on the correct path and will be able to reach your savings goal in time. A simple spreadsheet can help or you can just log into our account on a regular basis to check.
How to set up a sinking fund for beginners summary
A sinking fund is important for covering anticipated expenses. It can help with saving money for big life events, holidays, or annual car insurance payment. With a proper sinking fund, you should never run out of money for anticipated expenses.
Setting up a sinking fund is easy. You need to open a savings account or high-interest current account separately from your main account. Then you calculate how much you need to pay in monthly to cover the costs and proceed to set up a standing order.
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