Photo: Free Images, CC BY 2.0, via Wikimedia Commons
Every January, a lot of people open a credit card statement and find December sitting there. Gifts, travel, a couple of nights out and the extra grocery runs all happened in the same few weeks, and none of it was a surprise. Christmas has been on December 25 for some time now.
The fix has a dull name. A sinking fund is money you set aside, a little at a time, for a specific expense you know is coming. It doesn't make anything cheaper. It just moves the pain from one bad month to ten or twelve mild ones, which in my experience is the difference between a budget that holds and one that gets abandoned by February.
This is general information, not personal financial advice. Your numbers and priorities will be different from anyone else's.
Where the odd name comes from
The term comes from public and corporate finance, long before anyone used it for a gift budget. Governments and companies set up sinking funds to put money aside regularly so they could pay off a debt when it came due, instead of scrambling at the end. Britain set one up in the 1710s, under Robert Walpole, to chip away at the national debt. Plenty of corporate bonds still come with sinking fund provisions today.
Ordinary savers borrowed the idea and kept the name. The money "sinks" the cost before it arrives. I'd have picked a cheerier word, but nobody asked me.
A sinking fund is not an emergency fund
People mix these up, and it matters. An emergency fund covers things you can't predict, like losing a job or the boiler dying in January. A sinking fund covers things you can predict, at least roughly. The holidays are the obvious one. So are annual insurance premiums, car registration, a school trip that the letter home warned you about in September, the vet's annual checkup, and the birthday that falls on the same date every year (no matter how surprised some of us act).
Keeping them separate protects the emergency fund. If you raid it every December, it isn't there when the boiler goes.
The arithmetic is the easy part
Take the expense, estimate the cost, and divide by the number of months until you need the money. That's the monthly amount.
Here is a made-up example to show the math. Say you expect to spend $600 on the holidays next year and you start in January. That's $50 a month. Start in July instead and it's $100 a month, which is why the best time to begin is just after the thing you're saving for. If you start now for this December, you may only cover part of it, and covering part of it still means a smaller bill in January.
For costs that vary, use what you actually spent last time. Your bank and card statements are more honest than your memory, and they tend to tell you the holidays cost more than you thought.
Where to keep the money
The money needs to be separate from your everyday checking account, or it will get spent on everyday things. A savings account works well, ideally one that pays interest. Many banks and credit unions now let you open several savings accounts or label sub-accounts, so you can have one called "December" and another called "Car insurance" and see each balance at a glance.
In the United States, deposits at FDIC-insured banks are covered up to $250,000 per depositor, per insured bank, for each ownership category, and credit unions have similar coverage through the NCUA. A sinking fund for gifts is very unlikely to bump into that ceiling, but it's worth knowing your money is somewhere protected.
Some people prefer cash in labeled envelopes, and if that works for you, fine. I'd just point out that envelopes pay no interest and are easy to borrow from "just this once."
The old Christmas club did the same thing
None of this is new. For much of the 20th century, American banks offered Christmas club accounts. You signed up early in the year, paid in a small fixed amount each week, and got a check in late autumn for holiday shopping. The idea is usually credited to a bank in Pennsylvania in the early 1900s, and the clubs became a fixture of small-town banking for decades.
The catch with many of those accounts was that they paid little or no interest, and some charged a penalty if you withdrew early. A modern savings account with automatic transfers does the same job and usually pays you for it. Still, I think the clubs got one thing right. Money with a name and a date on it is harder to spend on something else.
Setting one up this week
Start with a short list. Go through the last twelve months of statements and write down every expense that was predictable but irregular. Pick the two or three that hurt most and set those up first. You can add more later.
Then automate it. Schedule a transfer for the day after payday, so the money moves before you have a chance to spend it. Small amounts are fine. A sinking fund that covers half of next December is far better than a perfect plan you never start.
Finally, check in once or twice a year. The insurance renewal is rarely the same number two years running, and the gift list has a way of getting longer. Adjust the monthly amount when the estimate changes, and when the bill finally arrives, pay it from the fund and enjoy the rare feeling of having seen something coming.
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