Avoid Holiday Debt By Using a Sinking Fund

• A sinking fund is money set aside to handle an upcoming expense.
• Unlike an emergency fund, money added to a sinking fund is used for a specific reason.
• You can save for Christmas expenses year-round without accumulating debt when you have a sinking fund. 

The holiday season is the best time of the year. The lights, decorations, family, and gifts, all make the holiday season more memorable. Even the debt can be something to remember. But who wants to remember the debt you accumulated while trying to make wonderful memories with your family? No one.

If you are consistently struggling with debt every holiday season, you may want to consider using a sinking fund.

What is a Sinking Fund?

In business, a sinking fund is money put aside over time to pay off debt before the maturity date. It is literally a fund to stop the business from sinking when that debt becomes due.

This idea has been adapted to households and can apply beyond the limits of paying off debt. 

Let’s say you have a big-ticket item that you want to pay in full by next year. You need a new roof, a new kitchen, a new car, a nice vacation, a new transmission, or anything else that you can predict needing money for in the near future.

First, you must figure out how much money you need to budget to pay for these items. Second, you must divide that by how long you have to pay for them and then start putting that much aside every month to handle that expense when it arrives.

Sinking Fund Example

For example, you need a new car, and the car you want costs $10,000. You don’t have that much sitting in your bank account, so you start a sinking fund. Your current car will last you with a bit of maintenance for another two years or so. 

That means you can split the payment up over that time. To make it easy, we’ll say you want to buy it in 20 months. Divide $10,000 by 20 months, and you will need to put $500 a month into your sinking fund to purchase the car.

By consistently putting money into your sinking fund, you have money on hand to handle big-ticket expenses without being surprised or going into debt to handle them.

The Difference Between Sinking Funds and Savings Accounts

Savings Account

First, a savings account is just a type of account at a bank. It is called that to motivate you to put money into it, but there is nothing that requires you to “save” in a savings account. Second, a savings account is rather ambiguous, meaning when you have money in a savings account, it is there just to be saved.

Sinking Fund

A sinking fund has a specific purpose behind it. You can have a sinking fund to save for the car you want to buy and a sinking fund for the new roof that you want to purchase. You can have more than one sinking fund because each sinking fund has a distinct purpose. If you have a sinking fund, chances are you are intentional about your money and savings goals. 

The Difference Between Sinking Funds and Emergency Funds 

If a sinking fund isn’t the same as a savings account, then surely it is the same as an emergency fund, right? No. This is yet another way to save.

Emergency Fund

An emergency fund is for just that—emergencies. When your child breaks a tooth and needs to go to the dentist, the heater breaks mid-winter, and you need to buy a new one, or your car needs a new transmission, these are considered emergencies. You didn’t know they were coming, but to prepare for them, you put money in an emergency fund. 

An emergency fund must be between three to six months worth of expenses saved in your savings account. You can save little by little or however much you choose. Once you hit your goal of having at least six months' worth of expenses, you can continue to save, or you can pause on saving. An emergency fund is designed to help reduce stress and provide you with financial security and relief.

Sinking Fund

A sinking fund is different because you have a specific reason as to what you are saving up for and the dollar amount in mind for that fund. A sinking fund can be used for an upcoming expense like a new car, vacation, or gaming system. None of these are emergencies, so the funds should not come out of an emergency fund. 

A specific sinking fund is made to be filled up and used, while an emergency fund is meant to be kept full or refilled perpetually.

How Can I Use a Sinking Fund to Avoid Holiday Debt?

Now that we understand what a sinking fund is, how can we use it to avoid holiday debt? Paying for the holidays is just as much a sinking fund expense as buying a new car or going on a vacation.

You simply determine how much you plan to spend on the holidays for a given year and then start saving up for that over the course of a year. To figure out how much you need to spend, consider looking at your credit card statements or bank statements from last December and going from there. If you spent $1,200 for Christmas, you will need to put aside $100 a month starting in January to build your sinking fund enough to pay for it in full.

If you are already in holiday debt, that may seem daunting. Remember to pay off consumer debt as quickly as possible, but also start saving just a little bit to get into the habit. Over time you’ll have enough money in your sinking fund to pay for holiday expenses without going into debt, and then you’ll be much better off.

Recommended Reading: Seven Ways to Save Money During Christmas

How to Use a “Money Challenge” to Grow Your Sinking Fund

If you like the idea of a sinking fund, but you’re unsure you’ll be able to stick to it, consider doing a “money challenge.” In general, a money challenge is any time you “gamify” saving money. There are many ways to do this, but here is one idea.

“Money Challenge” Example

Break up your saving goal into 12 or 24 chunks (depending on how often you get paid) that are all different amounts. Some are larger, and some are smaller. Then put those varying amounts on a chart and make a point to mark off an amount every time you save that much from one of your pay periods.

This way, you can save more when you have fewer expenses and less money when months get tight, but you’re still saving. By doing this, you will save money to avoid holiday debt while having a bit of fun doing it. If you’re competitive, it may even prompt you to beat your savings goal.

Recommended Reading: Buy Nothing Day, Should You Participate?

The Money Wrap-Up

Holiday debt can be very stressful, and it may seem like you can never get out of it. But, using a sinking fund can allow you to spend wisely and meet your financial goals throughout the year instead of scrambling to find the money come Christmas time. Sinking funds are one of the most powerful ways to prepare for upcoming expenses and live debt free.