Wanjiku has a simple spending philosophy: she will always pay for everything in cash and plan her purchases. Whether it was a Ksh5,000 handbag or a holiday vacation, it didn't matter. She took time to plan and save. She picked up these good financial habits when earning less than twenty thousand per month ten years ago.
She struggled to pay for expensive things and couldn’t qualify for a loan. So Wanjiku asked her mother, a banker, how she could afford costly items on a small salary while also planning for the future. Her mother recommended she start a sinking fund whenever she needs to make a big purchase.
To buy her first bed, Wanjiku created a lock-saving M-Shwari account and saved Ksh1,500 per month for five months. At the same time, she was also saving Ksh3,000 for future use. She could’ve been able to afford a new bed by saving for two months, but she decided to take her time. She prioritised her current needs while planning for the future.
Today Wanjiku is 35, earns Ksh90,000 per month, and is going strong with her money philosophy and habits. Her gift to herself this holiday was a new laptop. She created a sinking fund and slowly saved for the purchase for 15 months.
So why does Wanjiku use a sinking fund, and why does she swear by it?
This article will explore what a sinking fund is and five reasons you should start one in 2023.
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A sinking fund is a strategic way of saving money for a large purchase or future expense. It involves setting aside a small amount of money every month (or any other interval that works for you) to finance that purchase or expense.
A Sinking Fund lets you set aside a small amount of money and build up savings to cover a specific expense in the future. The idea is to help you manage your finances more effectively and avoid spending a large sum of money at once without any planning by spreading the process over a longer timeframe.
For example, you own a car, and you just bought a new set of tyres. You plan to keep the car for the next five years. That means that within the next two years, you will need over Ksh30,000 to change all the tyres. Since this is a future expense you can't avoid, you can set up a sinking fund and save Ksh1,500 per month for 24 months to have funds available to buy a replacement set in two years.
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Now that you know what a sinking fund is and how it works, why should you create one? What are its benefits? Why should you start saving to buy a new set of replacement tires when you just bought new ones?
Sinking Fund does more than help you plan for future purchases. It can give you peace of mind knowing that you have dedicated savings to fall back on when a bill is due. It helps you plan your future expenses with ease. And that's not all.
Here are five reasons you should start a sinking fund in 2023:
The main reason for starting sinking funds is to avoid consumer loans. Given how accessible they're, it's easy to find yourself spendings money you don't have and living beyond your means. Today, if you don't have the money to buy a new home appliance, you can walk into any major retailer and purchase the product on Buy Now, Pay Later terms. This concurrently leads you into debt and puts stress on your future income.
Using debt to finance your purchases has many implications. First, it's more expensive. Merchants are likely to sell to you with higher markups, you won't have bargaining power, and worse, you might have to pay loan fees, including application costs and interest. Second, you can develop cash flow problems leading to a debt cycle. This is because you will always run a budget deficit when much of your income goes to servicing loans. Thirdly, you can hurt your creditworthiness when you default and lose the collateral.
Sinking funds can help prevent all this in simple ways. You can save for future purchases without risking your finances or using money you don't have. This will enable you to stay more focused on your goals as you are not constantly in debt. You will be able to manage your finances more accurately and avoid financial stress.
Read Also: How to Avoid the Trap of Consumer Debt
Have you ever been invited to a WhatsApp wedding fundraising group or baby shower where gifts are compulsory? These are common occurrences today. While you might make your contributions or go to the shower bearing presents, you might wonder why someone would take such significant life steps without preparing their finances. It's simply because they don't save for such events.
Which leads to the question, what can you do to avoid inconveniencing your loved ones by holding fundraisers every time you make a major life decision? The answer is simple, keep yourself prepared using the sinking fund strategy.
A sinking fund allows you to save for these events and pay for them out of pocket. It ensures you stay responsible, respect people's money boundaries, and not shift your financial burdens to others. When you are self-reliant, you can avoid ridicule, earn your peers' respect, and live within your means.
So when you hold a shower when expecting a baby or getting married, it won't be an opportunity to fleece your loved ones. It will be a reason to celebrate the new arrival and mark a special time in your life. Attendants will be able to show love and support without feeling you are financially draining them.
Sinking Funds can help you develop good spending habits in three ways. The first one is that it enables you to avoid money wastage by ensuring your money has a purpose at any given time. Once you receive your income, you will allocate money across your sinking funds before you can misappropriate it. Giving your money purpose allows you to stay motivated, prioritise spending, and make good money decisions. You will be able to cut expenses and stay focused on your goals.
The second way sinking funds help you get rid of bad spending habits is by postponing gratifications. You will be able to avoid temptations that lead to impulsive purchases. Instant gratifications can lead you to spend money you don't have or dig into your savings to finance expenses that don't align with your goals.
This practice can delay your goals and prevent you from saving. With a sinking fund, you will be more inclined to save money and plan every purchase. You will be mindful of how you spend, and you will be able to avoid temptations that can hurt your finances in the long term.
Finally, a sinking fund allows you to create a budget for unnecessary spending. You can create a fund and save specifically for your miscellaneous items. This will make you feel less guilty when you spend over ten thousand on a designer t-shirt or to pimp your car.
Read Also: 5 Good Financial Habits to Start in 2023
It's easy to confuse emergency funds with sinking funds, but these are two entirely different strategies. An emergency fund, as the name suggests, helps you prepare for emergency expenses, e.g., car breakdown or medical expenses. On the other hand, a sinking fund enables you to prepare for planned expenses, e.g., biannual dental appointments or car repainting.
A sinking fund acts like a go-between. It allows you to save for expenses outside your budget while preventing you from digging into your emergency savings. This ensures that your emergency fund is always preserved for, well, emergencies.
A sinking fund does more than just prevent you from misusing your emergency fund. It can help you prepare for an avoidable expense. Take medical bills as an example. You can’t predict when you'll get sick and how much you'll need to pay to get better. With a sinking fund, you can always ensure that you pay your insurance on time to afford healthcare. Immediately after you pay your annual premiums, you can set up a new sinking fund to help you save for next year's premiums.
Such practices ensure your rainy day funds are preserved for the most unexpected emergency, like job loss.
Saving money is not a new concept. You have saved money for a specific purpose at one point or another. Or you are even doing it now. If you have a pension fund, for instance, that is a sinking fund for retirement. It's just separated from your other savings account.
Throughout the year, you usually save for different things in advance. You save for birthday gifts, holidays, or travel. But when you do this, you could usually save all this money in one account. This comes with some risks; the biggest one is you end up using the money for a different purpose since it's hard to keep track. You might take a vacation and spend more than you saved for that purpose.
Sinking funds help you avoid such mistakes by separating your savings accounts and formalising how you save money. You can have different accounts for travelling, birthdays, home maintenance, emergency savings, etc. And NO, you don't need to have ten different bank accounts. If what you are saving for costs less than Ksh10,000, you can use envelopes at home or savings options provided by your service provider.
In 2022, Mary created different sinking funds using M-Shwari, M-Shwari lock saving account, KCB MPESA, and KCB MPESA lock saving account.
However, you will need to create separate bank accounts for bigger sinking funds like buying a car or a house. Keeping all this money at home or in easily accessible mediums can be risky.
Read Also: What is a Sinking Fund and Why You Need One
A sinking fund can help you plan for purchases, stay on top of your finances and avoid debt. But to reap the benefits, you will need to focus on your goals and keep your bad spending habits at bay. Start by having a clear plan in mind. If you don't know what you are specifically saving for, your sinking fund isn't a sinking fund, and saving with no purpose can be difficult.
When starting a sinking fund, you should have a solid estimate of how much you need to save. This will prevent you from digging into your savings or taking out a loan to top up your money when an expense is due. Therefore, crunch the numbers, track your progress and be flexible.
Finally, be mindful of where you keep your sinking funds. Depending on the time horizon and how much you want to save, you can choose an envelope, money saving box, or open a bank account. If you are creating a sinking fund for long-term goals, you want your money to generate income and benefit from compounding. Therefore, choose saving instruments with those features.