Editor’s Note: This story was originally Penny Horder.
Do you wish you had saved more money? Rather than an emergency fund to cover unexpected expenses, is it something that can ease the financial stress caused by life’s major events?
When Nora Martin was expecting her first child, she wasn’t going to let all of the many birth costs get her down.
“I wrote down pretty much everything I needed … and divided the total over six months to see how much I had to save each month to reach my goal,” says Martin. say.
This practice of breaking up large financial goals into manageable chunks has a special name in the world of personal finance.
What is a depreciation fund?
A depreciation fund is a pool of funds that you donate regularly to spread the cost of future expenses over time.
A depreciation fund is different from an emergency fund or a standard savings account because it is specifically allocated for large expenses or high value items.
The term “thinking fund” comes from corporate finance terminology. Companies put money into depreciation funds to pay off debts and bonds and to prepare for large capital investments.
But you don’t have to own a business to benefit from this saving strategy.
Learning to add depreciation to your budgeting approach is a smart strategy to save for big money goals, future financial obligations, and recurring bills other than regular monthly expenses. is.
Why do we need a depreciation fund?
Why set up a depreciation fund rather than dump all your money in one of your other savings accounts and call it a day? Here are some reasons to start a depreciation fund account: is shown.
A sinking fund helps manage the high costs of major life events
Storing money in a depreciation fund helps you manage future expenses that would be overwhelming if you failed to plan ahead.
If you don’t have a lot of monthly disposable income, it can be difficult, if not impossible, to cover large expenses at once.
For example, if you waited until December to buy Christmas presents and were planning to spend about $800, you might be forced to charge your credit card to make it happen.
If you keep money in a separate savings account for a period of time (say, $100 a month for eight months), you won’t need to go into debt or borrow money.
Sinking funds save emergency funds for real emergencies
By having depreciation, emergency fund When you have a large (non-urgent) expense.
Likewise, there’s no need to pause progress on other money goals, such as paying off long-term debt or investing in retirement.
Depreciation helps weather the variable income storm
Sinking funds make future spending more manageable. And when it comes time to actually spend the money, you can do so without guilt, knowing you’ve been specifically saving for that purchase.
Sinking funds are also a lifesaver if you have variable income.budget may be tight If your income fluctuates month to month.
Sinking funds allow you to set aside money in high-earning months and use that cash in low-earning months.
Types of depreciation expense that can be added to the budget
The categories of depreciation funds to add to your budget will depend on your individual needs and desires.
Generally, there are three types of depreciation expense: planned targets, recurring expenses, and uncertain future expenses.
Planned goal Sinking funds
Examples of sinking funds that are considered planned targets include:
- newborn costs
- home down payment
- new car down payment
These are typically one-time expenses that you budget for, and you can stop saving when you reach your target amount.
Ordinary expenses Sinking funds
Examples of recurring expenses for which you want to set depreciation include:
- car insurance premium
- car registration renewal
- home insurance
- Christmas gift
- Birthday gift
- holiday spending
- back to school shopping
- Summer camp fee
- self-employed tax
- annual subscription
- computer software updates
- credit card annual fee
These are costs that we know will occur around the same time each year and need to be planned on an ongoing basis.
uncertain future costs
An uncertain future expense is an expense that will inevitably occur, but it is not possible to plan when it will occur or the exact amount required. These include:
- Medical bills
- car maintenance or car repair
- home repair or maintenance
- appliance replacement
Please do your best to estimate the quantity needed. It helps to see past spending in these categories.
Difference Between Depreciation Fund and Emergency Fund
The emergency fund should be kept separate from the sinking fund. They are not the same thing and should ideally be kept in separate savings accounts.
A sunken fund is a predictable planned expense. An emergency fund is a safety net that should only be used in emergency, critical and unforeseen circumstances.
For example, use the sinking fund money for plane tickets to visit your mom on vacation.
But if your mom has a car accident and you need to book a last-minute plane ticket to help her recover, then use your emergency fund.
How to save money with a depreciation fund
It takes a little math and organization, but it’s not hard to save money with depreciation.
First, you need to figure out the total amount you want to save. Then divide that amount by the time until you need to spend the money.
This gives you the amount you need to set aside in the depreciation fund each month (or week or payment period).
For example, if you want to save $1,000 for vacations of 10 months or more, you must add $100 to your vacation fund each month.If you’re not good at math, you can use one of the online Sinking Fund Calculator to solve.
Sinking Fund Account Types
Depreciation typically covers short-term savings goals, so the money should be easily accessible. Keep it in a high-yield savings account or a money market account with attractive interest rates.
Those who prefer the envelope method can store their depreciation fund savings in cash.
If you manage your money with a budget app, you can set your sinking funds digitally. mint is one of my favorite budgeting apps that doesn’t charge monthly fees.
For long-term goals, a Certificate of Deposit (CD) is another option to store your money and watch it grow, but only if you know you won’t need to withdraw it before the CD expires. increase. If you withdraw your money too early, there will be penalties.
Keeping your savings in a brokerage account may give you the greatest return, but it’s generally not recommended to sink your money as you risk losing your savings due to stock market volatility.
5 tips for success with depreciation
Become a depreciation pro with this advice.
1. Separate depreciation expense from main checking account
It’s useful to keep your sinking fund funds in a separate account so you don’t spend your savings on Uber Eats or make impulse purchases on Target.
2. Name the Depreciation Fund Account
Giving your sinking fund a name like ‘Italy Trip’ or ‘My Dream Home’ can help motivate you to keep saving Don’t indulge in it for frivolity.
3. Automate the transfer of savings
By setting up automatic transfers or direct deposits to your depreciation fund account, you can streamline the process of saving so you don’t even have to think about doing it.
Setting up depreciation on your checking and savings accounts makes it easy to automate transfers.
4. Apply windfall to depreciation
If you receive extra money, such as bonuses or tax refunds, don’t wait. Add to your sinking fund today to accelerate your progress towards reaching your financial goals.
5. Prioritize multiple savings goals
With all the reasons why you should start saving money, setting aside money for all these expenses can seem overwhelming. Prioritize needs like taxes and insurance over wants like vacations and holidays.
And know that you don’t have to save it all at once. Make a plan to reach your money goals that are workable for you and your financial situation.