Dubai: Forget living paycheck to paycheck and ditch the budgeting blues! We all know the drill: Track groceries, rent, bills, then cry at the end of the month realising you spent it all on lattes.
But what about those financial curveballs like car repairs, house woes, or surprise medical bills? They can leave you feeling like you're juggling flaming chainsaws while wearing oven mitts (not recommended). That's where sinking funds come in - your financial superhero cape to conquer those unexpected expenses with calm and confidence.
“In a given year, you likely have expenses that you know are coming – holiday gifts, the family vacation you take every summer, maintenance fees for your home or maybe membership renewals for different services you avail,” said Abrar Younis, a financial planner based in Abu Dhabi.
“But just because these costs are predictable doesn't mean you're always prepared. If you are pulling from your emergency fund or using a credit card to cover predictable costs, you might consider using one or more ‘sinking funds’.”
“‘Sinking funds’ cover costs that tend not to occur every month and can, therefore, be overlooked when people track expenses and estimate how much they spend. If you aren’t paying close attention to your finances, these expenditures can derail you and even land you in debt,” explained Younis.
‘Sinking fund’: Not having one wreaks havoc on your budget
After finding it easier to track routine costs initially, Dubai-based wealth advisor Mohammad Shaan said a key reason why so many struggle to stick to a budget in the longer term is because they fail to plan for larger expected expenses.
“Despite initially setting aside money for the purpose of finding money to fund one-off emergency events, many of us find ourselves dipping into emergency savings to cover expected expenses such as school fees, car insurance, flights, housemaid visas or rent,” he added.
“You can add ‘sinking funds’ to your budget for expenses that come at the same time each year or to plan a big purchase you want but don't necessarily need – like a new couch for your living room or that piece of exercise equipment you've been eyeing for months.”
How are ‘sinking funds’ different from other savings accounts?
A sinking fund is different from other kinds of savings accounts – like an emergency fund or a traditional savings account – in a few ways, and because they have different purposes, separating sinking and emergency funds is wise.
“While an emergency fund is for true emergencies, your sinking fund is for a planned purchase in the future that we know is coming. It is good to separate the two because otherwise it is a little bit tempting to dip into your emergency fund for things that aren't really emergencies,” added Younis.
“Sinking funds also differ from traditional savings accounts because each of them should have a specific goal and target deadline. That helps you track progress on multiple goals while putting all your savings into one large pot can get confusing and make you lose sight of your goals.”
While an emergency fund is for true emergencies, your sinking fund is for a planned purchase in the future that we know is coming
Why does it help for each ‘sinking fund’ to have a target date?
It helps for each sinking fund to have a target date as such a deadline is a strategic way to plan responsibly for that purchase. For example, if maintenance fees associated with homeownership are due in May each year, you can start planning ahead to have the cash on hand.
Here’s another example: If annual dues are Dh500 and you have six months to save, you need to put about Dh83 a month in your sinking fund. You can also use windfalls like cash refunds or gift money to boost these accounts and reach your goals faster.
“If you are finding it hard to keep track of costs that come up every few months or even once a year, it would help you to put money into sinking funds based on priority and necessity,” said Shaan. “Required fees or memberships should come before wants, like a new couch or exercise bike.
Can you have too many ‘sinking funds’? Finding a balance is key
Younis further added that the trick with sinking funds is striking the right balance. “You can absolutely overcomplicate your finances by having too many of these sinking funds. You might find that having multiple savings accounts to fund with each salary feels overwhelming,” he added.
Setting up auto-pay might be one way to help streamline things as some banks offer customers the option of having to customise savings within their bank accounts, said Younis, while adding that you don't really need a separate sinking fund for every single little expense that you are anticipating.
“You can always add more sinking funds if you find this strategy works for you. If you have leftover money in a sinking fund, either keep it there for next year, reallocate it to the next priority or pad your emergency fund, if needed.”
Bottom line: Are sinking funds right for you?
Both Younis and Shaan agreed that sinking funds are widely accepted as a low-risk strategy for saving for expected future costs. “I believe sinking funds can be for anybody no matter where they are with their finances,” added Shaan.
“Managing sinking funds also trains us to create healthy financial habits in our lives to prepare for the things that are putting us in debt. Also, noting upcoming expenses is a good way to get ahead of predictable costs and prevent unwanted debt or dipping into your emergency fund.
“Once you set aside money in your sinking fund, it is there for you to use for future payments and fees. The use of sinking funds is a method in which you give your current money a future purpose to be spent – and eases the pain of paying a large bill all at once.”
