How would your life be better if you were totally debt-free? Is it even possible to navigate life without debt?
Imagine paying cash for your next car. Not everyone goes deep into debt to send their children to college. Some families remodel their kitchen without a cash-out refinance. With a little bit of planning and proper execution, you too can permanently kiss debt goodbye.
Getting and staying out of debt is not solely for the rich and affluent. Financial peace is available to anyone willing to pay the price. It requires vision, planning, execution, and flexibility but it is possible. The key to permanently staying out of debt is a sinking fund. A sinking fund is vital to a solid financial plan. This fund is created when a specific amount of money is set aside, each month, for future purchases.
What Is a Sinking Fund
A sinking fund, in the world of business, is an account established to eventually pay off a bond. Bonds are issued by companies, churches, and governments to raise operating funds. During the life of the bond, only interest is paid to the bondholders. Eventually, the principal is due.
Imagine that a school issues a ten-year bond. The total amount of debt sold was $10 million dollars and the interest rate is 5%. The school pays 5% of the $10 million in quarterly installments to the bondholders. At the end of the ten years, the school has to repay the full $10 million.
Where do they get the money? A sinking fund. The school district needs to find a way in which to save $833,333 per year so that when the ten years are up the money is available.
Personal finance professionals have wisely borrowed the concept for us with individuals and families.
Vision For a Sinking Fund
Thinking about what sinking funds would be helpful does not cost a cent. However, it’s not as easy as it might first seem. In order to establish a sinking fund, you must look into the future and determine what you will eventually require or need.
Christmas is an easy example of looking into the future and planning expenses. Christmas reappears every year on December 25th. The first check after Christmas the sinking fund begins. Let’s say you want to spend $500 on Christmas next year. You are paid two times per month or twenty-four total checks. You would need to put a little bit more than $20 per check into a savings account to get close to your goal. That’s an easy one with a 100% occurrence at the same time each year.
What about others?
Some of the others can be a bit more complicated. They often require laser focus and unwavering commitment. Household appliances typically remain functional for about ten years. If you recently replaced your kitchen appliances it would be wise to start saving a small amount monthly for that future purchase. Twenty bucks a is much easier than writing a single check for $2,400.
Crucial Sinking Funds
There are some high-priority sinking funds that you simply do not want to gamble on.
- Real Estate Taxes. Homeowners never want to mess with taxes. If you do not have your real estate taxes escrowed then you must set up a sinking fund for taxes. You probably are already doing it but possibly didn’t know that it was called a sinking fund. If you have the discipline to do this it’s better than allowing the bank to do it for you. They’re using your money for free.
- Flexible Spending Account. Flexible spending accounts are one of the best-kept secrets in financial planning. However, no one is keeping them secret and only a fraction of families leverage this tax-defying gem. This is typically a payroll deduction into a tax-deferred account for future health-care expenses. Thousands of dollars can be socked away each year and the tax benefits are a genuine triple threat.
- College. At first blush, this might not seem to be a sinking fund but it is. One day Junior or Missy might want to attend college. You begin setting aside what you can and continue to do so on a systematic basis. If you begin early enough there will be a sizable sum available. I suggest getting assistance from a Registered Investment Advisor when you are ready to make this step.
- Home Repairs. Roofs eventually need to be replaced and siding and gutters will need to be refreshed. If you’re serious about winning at wealth you will make provision for these inevitable events instead of depending on debt to finance it.
- Auto Repairs. Batteries need to be replaced, starters stop starting, and AC units die. Do yourself a solid and prepare for the inevitable. Forewarned is forearmed.
Paying Cash For Your Next Vehicle
Not having a car payment is one of the best financial feelings in the world. Americans, for the most part, are trapped in a cycle of buying new cars with debt. Few people own their vehicles outright which makes getting ahead financially extremely difficult. The average car payment now eclipses $550 per month! That is a huge chunk of a family’s monthly budget.
If you are the person who wants to impress your friends, family, and neighbors with your vehicle you might not ever break free from auto debt. The “WOW” factor quickly wanes and constant upgrades are required to keep everyone jealous. You will probably finish your working career with a less-than-stellar retirement fund but at least you will have your vehicle glory days to fill your heart.
Most of us overspend when it comes to purchasing cars. The first step is to buy something that truly fits your budget. One prominent financial expert recommends not spending more than 10% of your annual salary on an automobile. The average annual salary in the U.S. is around $60,000. Using this advice, that family would only spend $6,000 when buying a car. Possible? Yes, but not if your motivation is to impress neighbors.
We decided to not borrow any new money a few years ago. At the time we were paying on a 2010 GMC Terrain. When that SUV was paid in full we simply diverted the monthly payment to a savings account. We were paying extra as well so that became our vehicle sinking fund. We recently purchased a 2016 Honda Civic with cash out of that fund. Now we’re starting over again.
We still have the Terrain and I drive a 2001 Toyota Camry — which I intend to drive for at least two more years.
What If My Budget is Too Tight
Perhaps you are a bit overwhelmed by all of the needs that you didn’t even know that you had. Sticking our heads in the proverbial sand and ignoring future events might seem less stressful but that’s a myth. It’s also a childish way to plan financially.
Disciplining spending habits is probably the most difficult behavior to overcome when getting on track financially. Most of us earn enough money to cover every needed area. Where we fall short is outspending our salary. If your salary is $50,000 per year that should be sufficient to cover most of these things (NYC, CA you’re outliers). When I earned $50,000 per year I did not have a boat or camper and had no business vacationing in the South of France.
Your first step is setting up a legitimate budget. Trim unnecessary expenses and do your best to improve your top-line salary.
Take care of your family first — food, shelter, transportation, utilities, and clothing.
Your first sinking fund should be your emergency fund. After your emergency fund is fully established begin attacking consumer debt. When that is wiped totally you should begin investing and establishing sinking funds.
Are Sinking Funds Difficult to Maintain
Sinking funds can be difficult to maintain but they don’t need to be.
I’ve heard of some people having multiple savings accounts at varying banks or credit unions. That’s a bit too complex for my simple brain. I have one primary savings account (an online high-yield account). I track debits and credits on a spreadsheet for each category.
It’s your fund so you get to decide which categories.
Sinking funds are a vital part of a solid financial plan. When properly established they will help you permanently stay out of debt.
I dare you to profit!
Tim Kiser is the author of The Profit Dare: Winning at Wealth Without Losing Your Soul. Additionally, he is a certified Master Financial Coach through Ramsey Solutions and a frequent contributor to Bible Money Matters.