Example of a Sinking Fund

A few years ago, I decided I wanted to go on one cruise each year, but I didn’t want to pay by credit card or take on other consumer debt. The money would have to come from my bank account. At the same time, I didn’t want to use my general savings, or sell any investments. So, I decided to put money aside month by month in a separate deposit account.

So far so good, but how was I going to find this money each month from my budget?

At the time I hadn’t heard of the 50-30-20 rule of budgeting. But, in hindsight, I think it’s useful to think of sinking fund categories in combination with the 50-30-20 idea. As a rule of thumb, it makes sense to split your monthly take-home income into three major spending categories, with 20% improving your wealth and the remaining 80% allocated to current living expenses and lifestyle.

50-30-20 is a reasonable split between the three categories:

• 50% on necessities
• 30% on treats
• 20% on improving your wealth (paying off debt, then building savings)

Within each of these categories, you can have various budget sub-categories.

For example, ‘holidays’ is one sub-category within the ‘treats umbrella’. Other treats might be eating out in restaurants, trips to the cinema, and books you read for pleasure.

At the time when I was wondering how to build savings for my cruise holidays, I was in the habit of going to a café every morning to plan my day. Coffee, cake, sit there with my notepad and pen. It was a pretty simple calculation. If I stopped going to a café every day (one treat sub-category), I would save enough in a year to pay for a cruise (a different treat sub-category).

So, that’s what I did. I saved for a specific purpose (as it happens, an example of a sinking fund). I reallocated some of my monthly income from one treat to a different treat, putting the money into a sinking fund rather than spending it each day on coffee and cake.

When you save for a holiday, you may know the approximate cost of the trip and roughly when you’ll need to make payment. That’s useful because you can then calculate how much you need to put into your sinking fund each month. For example, if you are going to pay $3,000 for a holiday in a year’s time, you need to save $250 each month (12 months x $250 to reach $3,000).

But with house repairs, it’s like saving for a rainy day. Some repair bills will be unpredictable, in terms of amounts and timing. Other bills may be more predictable.

Storm damage is an example of an unpredictable future cost. It will probably happen – sometime. Hopefully, the bulk of the cost of storm repairs will be covered by your home insurance. But you still have the excess to pay.

If you set up a sinking fund for unpredictable house repairs, how much should you pay into it each month? If you can’t make an accurate estimate of amounts or timing, you’ll have to make a judgement call.

Start by making a list of possible house repairs that will be too expensive to pay from your monthly cashflow. For example, unless you can do these yourself, you might include:

• Roof repairs
• External painting
• Internal painting
• Garden fence
• Plumbing repairs
• Electrical repairs
• Replacing items like fridges

You’ll need to estimate a rough monthly cost for each item, then total up the various monthly costs to arrive at the amount you’d like to pay into your house repairs sinking fund account each month.

For each item, estimate the total cost and then divide that cost by the number of months before you’ll need to pay it. For some items, timing is just a guess, but others may have a regular cycle. For example, external painting might be every five years. If it will cost $1,000 to paint your house (or maybe $6,000 if you have someone else paint it for you), you’d divide the amount by 60 (5 years x 12 months) to give yourself an estimated monthly cost.

Let’s say the total of all these future house repairs comes to an estimated $750 a month. That’s the amount you’d pay into your sinking fund account.