Transcript:

In the ordinary course of life, we have to pay for large items every so often. Whether it is buying an automobile or an aging HVAC, these large ticket items will eventually need replacement. We should plan for this type of expense outside of an emergency fund because we can predict them with a reasonable level of accuracy, and we tend to have plenty of notice when they are about to stop working. I want to introduce you to the concept of sinking funds to pay for large items without needing financing or stressing your monthly budget.

What is a sinking fund?

A sinking fund is nothing more than a specially designated savings account or fund to replace an item. You fund it by making regular transfers from a checking account, usually by including it in your budget. The term sinking fund is most often associated with corporations. Sinking funds are commonly used by businesses for all sorts of purposes, from replacing a $100,000 roof to retiring several million dollars in bond debt.

Imagine you moved into a house with an air conditioning unit close to the end of its expected life. Let’s assume you have three years left before the unit is likely going to need total replacement. You quoted local companies and researched online, and came up with an estimated $4,000 to replace it. Dividing $4,000 by (three years x twelve months) gives us a monthly savings goal of approximately $110. You can open an account for major home repairs and deposit $110 every month as an automatic transfer from your checking account. If you have multiple repairs or appliances to replace, you can use a spreadsheet to track how much you have saved for each one.

How far out should you prepare for an expense?

Although I broke down my last example over three years, the optimal timeframe to save for a large item is likely two years. Based on the air conditioning unit’s previous example, you will likely arrive at a monthly goal of $110 to $170. In the unfortunate scenario that your equipment or appliance stops working before you are done saving in a sinking fund, consider using any flexibility you may have in your current month’s budget and tapping into the emergency fund before considering debt.

Other purchases, like cars, allow us to plan for replacement based on our preferences. If you currently own a vehicle on payments, the priority is to eliminate that debt. Then, continue paying yourself that same car payment into a sinking fund to replace your car in the future. If you become impatient, add some extra money by squeezing it out of your budget, getting a side-gig, or allocating most of your bonus to it. In the end, you will feel much better knowing that the car on your driveway is entirely yours and won’t be at risk of repossession should you fall on hard times.