When Rob and I were drowning in debt and living paycheck to paycheck, we had no clue how to save money. We had no clue what sinking funds were nor did we know how to build an emergency fund.
Then in 2018 that we finally came to our senses and paid off $50,000 worth of debt. This debt pay off journey transformed both of us from spenders to savers.
We now use two types of savings accounts to help us prepare for our future.
- Our sinking funds is money that we set aside every month to pay for the known future cost.
- Our emergency fund is our survival fund. We are committed to setting aside a minimum of six months of living expenses that we will only be tap into for survival purposes.
To help us prepare for the expected and unexpected, we manage our money with savings accounts with purpose. Our goal is to avoid going into debt by managing our money through goal setting.
In this article, we will cover all of the wonderful benefits of utilizing savings accounts to build peace of mind and wealth. We will include a few of the most common questions regarding saving money.
- What is the difference between sinking funds and an emergency fund?
- How do you use an emergency fund?
- What are sinking funds?
- The Power of Saving Money
- An emergency fund helps to protect wealth
- Sinking funds can be used to build wealth
- How to get started making money
Sinking Funds Versus an Emergency Fund
While in debt, Rob and I continued to deposit money into our savings account. We did this because we felt like that was the responsible, adult thing to do.
The problem? We deposited money into our savings account at the same pace as we withdrew money from our savings account.
It is incredible how fruitless our savings plan was.
Following our debt pay off journey, our position with money has gone from reactive to proactive. We have been able to do this by setting up sinking funds and an emergency fund to secure our future.
So what is the difference between sinking funds and an emergency fund?
- An emergency fund is to help you survive an unknown, catastrophic event.
- A sinking fund is set up so that Christmas does no become an unknown, catastrophic event.
How do you use an emergency fund?
An emergency fund is used to make sure that you can financially survive if an unplanned, life-changing event takes place. Such as a job layoff, a major illness, or something of the like occurs, you have money to help you survive.
This is the savings account that you never want to have to use!
Your emergency fund is your safety net, and the size of your fund is going to depend on what your comfort level is.
When we started our emergency fund, we were following Dave Ramsey’s Baby Step Program. When paying off consumer debt, Dave Ramsey advises starting off with $1,000. Once all of your debt is paid off, Dave recommends building your emergency fund to three to six months of living expenses.
For us, we have made it to the milestone of a six-month emergency fund. Now we are working toward a twelve-month fund. We are doing this to build a safety net that provides us with the level of security we desire.
What are sinking funds?
Sinking funds are mini savings accounts with purpose. They are savings goals that keep your world afloat.
These little savings accounts make it possible to live your life without having to tap into your emergency fund. Sinking fund savings accounts make it possible for you to fund both your wants and your needs.
In the accounting world, the definition of a sinking fund is:
An account into which a person or company deposits money on a regular basis in order to repay some debt or other liability that will come due in the future. For example, if one has a loan with a balloon maturity of seven years, one may put money into a sinking fund for seven years in order to be ready to pay off the principal when it comes due.
The Financial Dictionary by The Free Dictionary
Sinking funds for our household budget are savings accounts that we store cash in for known upcoming expenses. For us, we utilize our sinking funds to prepare for our future.
Here are a few examples of sinking funds that we use:
- Annual Expenses: These are known expenses that are inconsistent and fall throughout the year such as gifts, auto maintenance or repair, and annual tax payments.
- Monthly Bills: Since our paychecks are weekly, we use our sinking funds to pay for our monthly bills such as our mortgage, utilities, insurance, etc. by setting aside money from each paycheck.
- Fun: We set aside a portion of each paycheck for travel and vacations. This allows us to plan out our vacations with the peace of mind that we have budgeted for fun!
- Personal: Rob and I do not purchase clothes or visit the salon monthly. Our personal sinking fund ensures that we have money when those expenses come up.
- Medical: For our medical expenses, we use our Health Savings Account (HSA) account. Our HSA allows us to save up and invest tax-free money to cover our medical costs.
- Credit Card Expenses: Although Rob and I racked up over $50,000 worth of debt, credit card debt was never our issue. We are one of those households that use our credit card to pay for everything, and then we pay off the balance in full every month. This sinking fund ensures that we have the cash on hand to pay off our credit card balances.
- Auto: Auto repair and maintenance is inevitable. By setting aside money every payday, oil changes, new tires, or a trip to the shop become manageable expenses.
- Gifts: Since Christmas and birthdays happen every year versus every month, a sinking fund will ensure that you are ready to shower gifts on your family without reaching for your credit card.
The Power of Saving Money
We have all heard of the lottery winners who win an unbelievable amount of money and end up spending everything. The rags to riches and back to rags stories are prevalent because wealth does not hinge on income alone.
You achieve and maintain wealth by actively managing the money that you do have.
For Rob and I, we have experienced the power of maintaining a monthly budget.
It is the active role that we play in monitoring our money, making plans, and setting goals that ensure we are living the lifestyle that we want while planning for our future.
If you haven’t tried budgeting, be sure to read up on some of our budgeting posts so you can start changing your financials today!
An emergency fund helps to protect wealth
The intent of an emergency fund is not to build wealth. The purpose of an emergency fund to help you to protect your wealth.
This is money that you:
- Set aside for peace of mind
- That you commit to not spending
- You promise yourself that you will only use this money to survive
The emergency fund is your survival fund.
It is not to be used to purchase a new pair of shoes, a house, a car, or pay for a family vacation. This is the money that sits there, earns some interest, but most importantly reminds you that you are not broke.
It is evident that you can do anything that you set your mind to.
After all, having three, six, or even twelve months of money set aside for a “just in case” is a true accomplishment.
The latest savings statistics for 2018 shows that the average American only saves ~2.2% of their income a year. In other words, it takes the average American 45.5 years to save just one year’s worth of living expenses. – Finanial Samurai
Sinking funds can be used to build wealth
Out of all of the definitions out there for sinking funds, I have yet to read any definitions that focus on how sinking funds build wealth.
But once you have the hand of what a sinking fund is and how to maximize their purpose, the wealth derived from these mini savings account is apparent.
Success or failure with money all boils down to you. If you are actively involved in managing your money and planning for your future, you will be successful. Being involved is key.
When you utilize sinking funds to plan for future dated expenses, you are making the ultimate commitment to building wealth.
Building wealth starts with proper planning at every stage of your life. Here’s a decade-by-decade look at what you can do to maximize your savings potential.
How to get started saving money
There is not a hard and fast rule regarding how much money needs to be saved every month. There are countless recommendations online advising of savings rates ranging from ten percent all the way up to sixty-five percent if you want to retire in ten years.
What you need to know is that there is not a magical savings rate that will build wealth. The key is being involved and committed to making sure that you can handle whatever financial challenges life throws your way.
1. Start a budget
To get started on your wealth building journey, make sure you start out with a budget. This budget will be your permission to spend. It will also provide you with documentation of your progress. Knowing where you started helps you to see where you want to be.
2. Set financial goals
Setting financial goals can be tricky sometimes. The unknown variables seem to stack up all around us.
- What will my earning rate be on my investments?
- How much do I need to have saved up to buy a house?
- What financial tool should I use to meet this goal?
- Is my investment portfolio too aggressive or not aggressive enough?
- Will one million dollars be enough to retire?
When it comes to our finances, sometimes we have more questions than answers. We are also faced with the emotions that cloud the decisions that we need to make for our future. That is where a trusted financial advisor can help you navigate through all the unknowns.
Sometimes we need to step back a bit and hire a professional.
Hiring a financial planner:
3. Plan for retirement
Retirement can feel so far away or right around the corner. When our children moved out, we realized that our next real milestone is retirement.
When researching retirement readiness, the statistics are shocking. Now is the time that you not only need to review your short-term goals of maintaining an emergency fund and setting up numerous sinking funds but also digging deep into your retirement goals.
With the uncertainty of social security and pension plans going bankrupt, now is your time to review your goals and ensure that you can fully fund all that you want to accomplish in retirement.
Our retirement plan:
4. Track your net worth
Your budget is your plan to build wealth. When you track your net worth, you get to see how all of your hard work and sacrifices are paying off.
What is net worth?
Net worth is the difference between your assets, the things you own, and your liabilities, the things you owe.
- Cash in the bank
- The current market value of:
- Stock investment accounts
- Retirement accounts
- Property (Home, rental property, vacation property, etc.)
- Items that you can sell (vehicle, boat, RV, etc.)
- Credit card balance
- Liens or judgments against you
- Medical payments
Monitoring your net worth is the way you can monitor your true financial health. It is a great progress tool that allows you to look back and celebrate where you are by seeing where you were.