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What Is A Sinking Fund?


Photo by Mishal Ibrahim on Unsplash

In personal finance, you may have heard of the term "sinking fund." A "sinking fund" is something used to reserve money for larger expenses that occur periodically but not monthly (called "sunk costs"). Here are some common expenses that are sunk costs.

1. Car insurance premiums.

2. Car repairs/replacement saving.

3. Life insurance premiums.

The good news is you don't have to be surprised by these or any other expected large expense. You can prepare yourself so that when these things happen, you have the money already set aside. Let's explore how you can do that.

First, add up all of the costs together that you need to cover in a year. Let's take as an example car and life insurance premiums from above. Say you pay $600 every six months for car insurance and your life insurance premiums run another $600 per year. Adding those up we get $1800 of expected, known costs in the year.

$600 (first 6 months car insurance)

+ $600 (second 6 months car insurance)

+ $600 (annual life insurance)

--------------------------------------------------------

$1800 (total sunk costs)

Next, break that number up into 12 equal payments and send that amount to a separate savings account each month. This account is your "sinking fund." Considering our example, $1800 divided into 12 equal payments is $150 per month deposited into your sinking fund.

$1800

÷ 12 months

----------------------

$150/month

Over the course of the year, you will have built in a mechanism for covering those costs when they come up. After 4 months you've saved enough to cover the next car insurance payment. By the time a year has passed, you have saved, and spent, the money without it becoming a surprise burden on your regular budget. This has helped eliminate a lot of stress from our yearly expenses. I know it will help you too.

So tell us, what are some other expenses you can consider as "sunk costs" that you can cover in a sinking fund? Let us know in the comments!

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