How to Create Sinking Funds

by Staff Writer on May 30, 2012

A different kind of sink

One of the best methods I have applied to my budget is the sinking fund.

A sinking fund can best be described as a pool of money that is set aside to cover future payments.

Think of it as a piggy bank that you put money into and when the time comes you get to smash the little piggy and use the money you’ve been saving. Sinking funds can be used for all sorts of expenses; taxes, insurance, big-ticket items, and even utilities.

My Sinking Funds

I personally have 8 sinking funds included in my budget to cover a range of expenses. Below is a list of all my ING Direct accounts.

list of ING Direct sinking funds

Most of these accounts are sinking funds. The housing fund includes the mortgage and taxes. I have a set amount of money I put in the fund every pay check. The money will sit there until each lender comes and draws their payments from the account. The taxes are paid twice a year and the money accumulates until needed.

The most useful sinking fund I have is my utilities fund. My cell phone, cable, internet, electricity, gas, and water are all included in this fund.

It has completely taken away ANY worry I have about the raise and fall of my utilities. It was pretty easy to set up and has been on auto pilot for almost a year now with zero interaction from me. I just transfer the same amount of money into the accout every pay period and that’s that.

Set Up a Sinking Fund

You’ll need to figure out what you want the fund to do. We’ll use a utility sinking fund for this example. The fund will hold the money for our cable/internet, electricity, household gas, water, and cell phones. The simplest way to start is to gather the cable/internet and cell phone bills.

These bills do not change much during the year. I suggest using a sheet layed out like the one below. 12 months across the top and the utility down the side. Plug in the payments for the cable/internet and cell phone bills. Next you need to pull out the gas, water, and electricity bills.

Most of these include the amount charged over the past 12 months. If they don’t, you can access all the information online at each provider’s website. Plug in the numbers for the past year. You need to use the previous years amount because they will give the best overall picture of how your house uses energy and how it changes during the seasons.

sinking fund

Once you have all the payments entered into the sheet you can sum the columns and see what it looks like. You can sum by month to get the total cost for each month, notice how it changes. You can sum by utility to see how much you spend each year, shocking I know. The last column on the right is the average per month for each utility, with the total amount averaged at the bottom. This is the amount you need to set aside every month to cover the bills.

I’m sure you’ve noticed that the total amount you need to set aside does not cover some of the month’s payments. Over time this will even out with some months being below the average and some above. This is where you can tailor the amount to provide protection from the ups and downs.

If you started this plan in February you’d overdraft the account. You can put a one time extra payment into the account to solve this problem. Dump and extra $150 in for this month and then scale back to $395 for the rest of the year. You’ll notice to that in July the number goes up quite a bit.

By putting the $395 into the fund from March until July you will have an excess of $226 sitting there to cover the extra needed in July (air conditioning costs a lot). Then the utilities drop down again, rebuilding for the next spike.

I’m a little more cautious when dealing with money these days. I will take the $395 and round up to $450 and deposit that amount every month. The extra money will build up the fund so that you never have to worry about how it is tracking.

If at some point you notice the fund is getting too much money it, you can pull some out to use for something more meaningful. The point is to always cover the expenses so your budget doesn’t get bounced around from month to month.

By using sinking funds, my budget is on autopilot and almost nothing changes from month to month. I LOVE Sinking Funds. They make the my financial life so simple.

Do you use sinking funds? Do you have a better way to cover these expenses? Please let me know, I’m always looking for the best ideas to use.

Photo By Andrew Mason