Sinking funds: Thinking backwards to plan ahead

The concept of a “sinking fund” might be as foreign to you as it was to me when I came across it a while ago. Just looking up the definition can be confusing since there are at least two uses for the term: A strategy for the repayment of a specific debt over a period of time. A strategy for funding a known future expense. Historically, the term originated in Great Britain as a game plan for paying off national debt. It was also used heavily in the railroad industry here in the U.S.
Investment companies define it as a type of staggered repayment that adds safety to corporate bonds. In the business world, a sinking fund might be created for the expected replacement or repair of assets such as equipment and buildings.
For you and me, the most practical application of a “sinking fund” is to set aside a monthly amount to fund a future expense.
Some financial advisors swear by using sinking funds for everything and anything — from trivial holiday spending to important purchases like a new vehicle or home. Some even use them to create a budget that’s more predictable (for instance, creating one big sinking fund that averages all your utility payments so you ‘pay’ the same amount each month, regardless of billing fluctuations).
Thinking Backwards, Planning Ahead, Waiting in the Middle
The purposes of sinking funds may be diverse, but they all require thinking backwards. Taking the amount of the purchase you want/need, and dividing it by the number of months you have to work with. For instance, if you know you want to spend $600 on Christmas gifts this year, and it’s July, you’ll need to set aside $100 from now until December.
Sinking funds also require planning ahead. In the previous example, saving $100 a month starting in July might mean digging for change in the car seats, but if you had started in January, it would be a more comfortable $50 a month. The further ahead you anticipate large bills and purchases, the less painful it will be to create the sinking funds for them (a great way to remind yourself is a dedicated financial calendar).
Patience, grasshopper. Children are taught patience by setting aside money in a piggy bank where they can’t touch the money until it’s ‘time.’ Think of a sinking fund as a piggy bank you get to smash when the time is up. How gratifying will that be?
Where to Stash It
Since sinking funds are mostly used for shorter-term savings, you shouldn’t need to deliberate over which investment account has the best interest rate or the right risk factor. If it’s a small amount (say, a $100 graduation gift for a senior), you can just stash it in that piggy bank, under your mattress — wherever no one will touch it. If it’s a larger amount that won’t be cashed out for a while, it might be safer in the bank. While it’s there, you might as well take advantage of higher-yield savings account that will earn a few extra dollars beyond your goal. Still, the main focus of a sinking fund is consistency in your deposits, not the rate of return.
The sinking fund isn’t a new concept, but maybe it’s as new to you as it was to me. Really, it’s just a smarter way to save for specific expenses and purchases by thinking backward, planning ahead, and having the patience to wait in the middle.

New savings strategies: Where do you keep your money?
Recently, TD Bank released the results of research that indicate that fewer people have savings accounts. What’s interesting about the results, however, is that this doesn’t mean people aren’t saving money — especially millennials.
Instead, it appears that many consumers are changing where they keep their money, moving it out of savings accounts. According to TD Bank, 70 percent of adults had savings accounts in 2014, compared with 83 percent in 2013. However, 59 percent of millennial say that they have savings to draw on, and 54 percent of gen-Xers said the same thing.
This trend toward finding other places to keep money is likely to grow over time. Even I don’t keep very much money in my own savings account.
So where do you keep your savings?

Taxable Investment Accounts
While I do keep a small amount of money in a savings account, it’s only enough to last me a few weeks in an emergency situation. I want that money to be liquid, but I don’t want most of my emergency fund sitting around earning practically nothing.
Instead, I keep most of my emergency fund in a taxable investment account. The returns are better, and if I do have to sell at a loss (as I did a few years ago when my home flooded), at least I get a tax deduction out of it.
I know others who use their Roth IRAs as emergency funds. Many tap into them for short-term needs and replace the money within 60 days to avoid penalty. This isn’t something I would do with my own Roth IRA, but it can work well. It’s one way to keep saving for the future and put the money to work at a higher rate of return.
Another alternative to a traditional savings account is to use CD ladders to build your savings and emergency funds. You can open a regular CD at your local bank or credit union and stagger the length of each — 6 months, 1 year, 2 years, etc. Then as each one comes due you’ll have a continuous amount of money become available to you.
Automatic Savings Apps
Another popular tactic is to use automatic programs that take small amounts of money and deposit them in accounts. Acorns.com has an app that will take your pocket change and invest it for a small monthly fee. I’ve been using Digit.co to take small amounts of automatic savings for me, so I don’t have to think about it.
Digit won’t pay you an interest yield, though. So, every few weeks, I move the money into my investment account. I’ll be moving soon, though, so I let Digit carry on with the automatic withdrawals without moving the money. My plan? Buy furniture with what has accumulated.
This strategy is an interesting way to save up for a short-term goal, and one that I think will allow me to furnish the deficiencies in my new home without changing up my spending plan or dipping into other assets.
I might not be earning anything on that money, but it’s slowly but surely going to benefit me, and wouldn’t provide me with enough to make a difference over a short period of time even if I did something else with it.
Thanks to all these new tools and mindsets, we have the chances to create new savings strategies. We are no longer required to follow one path.